Flash Comment US: No Summer Hike - Danske Bank
There was almost nothing good in the US jobs reports for May - and remember the jobs report for April was not strong either.
Employment rose only by 38,000, the lowest since 2010 (dragged down
35,000, however, by a Verizon strike). The two-months revisions were not
good either, totalling -59,000 and making the weak April jobs report
even weaker. The unemployment rate declined significantly from 5.0% to
4.7% but it was due to a shrinking labour force (the participation rate
declined from 62.8% to 62.6%) and not higher employment.
The one good spot was the earnings data as average hourly earnings rose +0.2% m/m in May in line with recent trends. The April rise was revised up to 0.4% m/m from 0.3% m/m. Wage inflation was unchanged at 2.5% y/y in May.
Based on the weak jobs report, we think a summer hike is now very unlikely . Recently, several FOMC members (including doves with voting rights) have stated that a hike in June or July would be likely if data were in line with their expectations of a rebound after a weak Q1. Most importantly, Fed chair Yellen said that a hike 'in the coming months' is likely in a recent speech. Although other data releases have been quite good, suggesting that the US domestic economy has picked up pace (see Strategy: US domestic economy picks speed, 27 May), we think the jobs report for May will weigh substantially on the Fed's rate decision. One of the most important input factors in the Fed's reaction function is employment.
We stick to our view that the Fed will hike in September but we need to see a rebound in employment so risk is skewed towards a later hike. The probability of a June hike according to market pricing has fallen from around 30% to 10%, July from 70% to 40% and September from around 85% to 60%. A hike this year is no longer fully priced in (all numbers are approximations).
On Monday, Fed chair Yellen is speaking in Philadelphia and despite the weak employment data, the speech will likely attract much attention , as we enter the Fed's silent period ahead of the June FOMC meeting. Also notice that Yellen testifies on monetary policy to the Senate Banking Panel on 21 June, not a long time before the July FOMC meeting.
The USD fell broadly following the data which is fair, in our view. Near-term, EUR/USD could head higher up towards the 1.14-1.15 area as the Fed is repriced, while the high from 5 May at 1.1616 should hold. We still look for some USD strength into a likely Fed rate hike in September. Longer term, we maintain our long-held view that EUR/USD should head substantially higher on valuation and eurozone-US current account differences towards 1.18 in 12M.
The weak labour market report has triggered a rally in global fixed income markets. 10Y treasury yields are down close to 10bp at 1.71% and 10Y Bund yields are downsome 5bp to a record low yield of 0.07bp. If this is reflection of a new underlying weakness in the US economy (contrary to our expectations) US yields can still be pushed lower . However, to see a new drop in yields we probably need more confirmation that the US economy is in fact slowing, a significant sell-off in global risk markets or a change in Fed rhetoric. We do not share the view that the report reflects a significant underlying weakness in the US economy and therefore still look for a September hike.
In respect of European fixed income markets this report was certainly not what the ECB had been hoping for. Other things being equal, the jump in EUR/USD makes it more difficult for the ECB to get inflation back on track. Hence, the move lower in European yields could continue depending on where risk markets and EUR/USD are going .
Given that we expect the Fed to resume its hiking cycle in September and as the market is currently pricing in very few hikes over the next two years we do expect higher US yields on a six to twelve months horizon. Eventually, hikes will roll into the US curve - but it will take time. We will next update our yield forecasts on 16 June.