Strong US Employment Data Derail Hopes for Quick Rate Cut

For the week ending 7 June 2024

As of midday Friday, global equities were just below the record-high levels set earlier in the week. The yield on the US 10-year Treasury note slipped 7 basis points to 4.43% from week-ago levels, but rates rose sharply from the week’s lows near 4.27% after stronger US payrolls. The price of a barrel of West Texas Intermediate crude oil fell $2 to $75.85 while volatility, as measured by the Cboe Volatility Index (VIX), fell to 12.7 from 13.6 a week ago.

MACRO NEWS

US labor market heats up again

Before Friday, having spent the past month or so discarding fears that the US economy was at risk of overheating, markets had settled on a soft-landing narrative of softer but not recessionary US growth, with data having become more mixed amid signs of a slowdown in consumer spending. However, Friday’s employment report called the soft-landing scenario into question, as 272,000 jobs were added to US payrolls in May, well above the consensus forecast of a gain of 180,000. There were only modest downward revisions to the prior two months’ payrolls of 15,000. Wage growth was stronger than expected, rising 0.4% month over month and 4.1% year over year, suggesting income generation remains solid. However, the unemployment rate rose to 4% from 3.9%. Markets were quick to price out one of the two US Federal Reserve rate cuts anticipated before year-end.

ECB cuts rates but future path uncertain

On Thursday, the European Central Bank delivered a promised 0.25% rate cut, lowering its deposit rate to 3.75%. However, the ECB raised its end-2024 inflation forecast to 2.5% from 2.3% while also raising the eurozone growth outlook to 0.9% from 0.6%. The central bank’s observation that domestic price pressures remain strong as wage growth is elevated and inflation is likely to stay above target into next year suggests that further cuts are unlikely to come in quick succession. Markets now expect a second cut to come in the fall, with about 75% odds of another one near year-end.

Surprises abound after EM elections

South Africa, Mexico and India held general elections in recent days, and they all produced surprises. In South Africa, the African National Congress fared worse than expected, garnering just 40% of the vote and thereby losing its outright majority for the first time since the end of apartheid in 1994. Efforts are being made to form a coalition before a 16 June deadline. In Mexico, the ruling Morena party appears to have narrowly missed out on securing a supermajority in the Senate while attaining a supermajority in the lower house of Congress, Supermajorities in both chambers would have paved the way for President-elect Claudia Sheinbaum to amend Mexico’s constitution, a prospect that made investors nervous. In India, wildly inaccurate exit polls predicted a landslide win for Prime Minister Narendra Modi’s Bharatiya Janata Party. However, final results show that the BJP fell short of a majority, forcing it to form a coalition to retain power. Indian share prices swung in a nearly 8.5% range in the wake of the election, first rallying on the exit polls and then sliding as the results became clear. When the dust settled, they ended the week up around 3.4%.

QUICK HITS

The Bank of Canada became the first G7 central bank to lower interest rates this cycle, cutting its policy rate 0.25% to 4.75%. Governor Tiff Maklem said it is reasonable to expect further cuts if inflation eases, though the path for rate cuts will likely be gradual.

France’s credit rating was downgraded late last week to AA- from AA by S&P Global Ratings, which cited concerns that the trajectory of government debt as a share of gross domestic product would increase through 2027 and not fall as previously forecast. As a result of the French downgrade, the rating on the European Financial Stability Facility was also downgraded to AA-.

After months of hesitancy due to opposition from his political base, US President Joe Biden signed an executive order Tuesday stipulating that migrants crossing the border illegally will not be able to seek asylum and may instead be deported. Biden had earlier contended that he did not have the authority from Congress to enact the restrictions.

OPEC+ said this week that it will normalize production over a longer timeframe than expected, but oil fell sharply amid concerns over slowing economic growth. Brent oil fell below $80 a barrel for the first time since February.

The US Bureau of Labor Statistics Job Openings and Labor Turnover Survey showed that job openings fell to 8.06 million in April from a downwardly revised 8.36 million in March. The April figure was the lowest since February 2021. The quits rate held steady at 2.2% while the ratio of the number of unfilled jobs to the number of those unemployed fell to 1.2, the lowest in nearly three years. A smaller number of job openings signifies softening demand for labor.

Data from the US Department of Commerce show that at a seasonally adjusted annual rate, Americans in the first quarter earned about $3.7 trillion from interest and dividends, up roughly $770 billion from four years earlier. Some economists suspect that extra income is contributing to sticky inflation.

Purchasing managers’ indices were mixed in May, though the important US services sector rebounded strongly after a dip below 50 in April.

A poll released Wednesday by American Compass, a right-leaning think tank, shows that 85% of Americans agree that “the budget deficit is a serious problem and the nation must be willing to take even painful steps to solve it.” Seventy-two percent of self-identified strong Republicans surveyed said they favor tax hikes as part of a deficit reduction plan.

In their first face-to-face meeting ahead of the 4 July general election, UK Prime Minister Rishi Sunak and Labor Party Leader Keir Starmer debated for an hour on Tuesday in Manchester. According to a snap YouGov poll, Sunak narrowly won the contest by a margin of 51-49. Sunak promised he would “cut your taxes, protect your pension and reduce immigration” Starmer said he would end “the chaos and division we’ve seen over the last 14 years.” 

Russian President Vladimir Putin said this week that it makes no difference to Russia who wins the US presidential election. He also said he thinks the criminal cases against former US President Donald Trump are politically motivated. Putin warned Germany on Wednesday that the use of its weapons by Ukraine to strike targets inside Russia would mark a “dangerous step,” and he said Moscow could in turn provide long-range weapons to others to strike Western targets.

US nonfarm productivity rose a downwardly revised 0.2% in Q1, down from a 0.3% preliminary reading. The unit labor costs number, a measure closely watched by the Fed, was revised down to 4% from 4.7%.

Bank of Japan Governor Kazuo Ueda said Thursday that it would be appropriate to reduce the pace of the central bank’s huge bond purchases but said the BOJ will move cautiously on rate hikes.

Elections for the European Parliament began Thursday and will continue through the weekend. Based on recent polling, centrist parties are expected to retain control, though right-wing populist parties are expected to make gains.