Fed Rate Hike Expectations Sensitive to Jobs Data

USD: Price action highlights potential for turnaround

After reaching a low of 4.73% on August 10th, the UST 2-year note yield has steadily climbed, hitting a peak of 5.10% on the following Monday. This translates to a 37-basis point increase in the 2-year yield over thirteen trading days. However, within just two trading sessions after that peak, two-thirds of this increase was reversed. This underscores how responsive the market is to data indicating economic fragility, particularly within the labour market—a concern that the Federal Reserve is closely monitoring. This sensitivity to economic indicators might impact the Fed's decision on potential further interest rate hikes.

Recent data, including the JOLTS (Job Openings and Labor Turnover Survey) and consumer confidence reports, have both fallen short of expectations, reinforcing the likelihood of a slowdown in the job market moving forward. While initial claims data has not been reassuring in this regard, it is worth noting that this primarily measures job terminations. The JOLTS data, which gauges hiring demand and job openings, has shown a more pronounced retreat than anticipated in July. While projections predicted a moderate decline to 9,500k openings, the actual number fell to 8,827k, with downward revisions to June's figures. Although job openings remain elevated, they are currently at their lowest point since March 2021. To put this in context, the average pre-COVID job openings figure over ten years stood at 4,900k, indicating a substantial gap to return to pre-pandemic levels in the labour market.

Several other factors, however, have normalized and will be of interest to the Federal Reserve. The Quit rate, which reflects voluntary departures from employment, dropped to 2.3%. This level was consistent with the figures seen throughout 2018 and 2019 before the COVID-19 pandemic. This suggests that wage growth may trend downward from its current state. Previously, Average Hourly Wages had been growing at around 3.0% between 2018 and 2019. Reduced job turnover tends to exert downward pressure on wage growth, as individuals switching to new jobs often secure higher paying positions.

The Consumer Confidence report also disclosed a decline in the Jobs Plentiful minus Jobs Hard to Get index to levels not seen since April 2021, a period when the labour market was still reeling from the impact of COVID-19. If we exclude the pandemic period, the reading of 26.2 was the weakest since April 2018.

The notable drop in US yields has cast a shadow over the favourable technical outlook for the US dollar. The EUR/USD exchange rate closed below its 200-day moving average on Friday, but it managed to stay above this level on Monday and in the subsequent day. This highlights the challenge of sustaining a breach below the 200-day moving average. Despite the weak economic data emerging from Europe, the EUR/USD exchange rate appears to be finding a support level around 1.0800.

EUR YIELD VS G10 POINTS TO EUR UNDERPERFORMANCE

Source: Macro bond & Bloomberg

EUR: Inflation in focus with ECB decision balanced

The euro's performance has been lacklustre, partially due to lowered expectations of additional interest rate hikes from the European Central Bank (ECB). Disappointing economic data has clearly influenced the ECB's perspective, leading to a shift in their tone and even the more hawkish members no longer showing a strong commitment to further tightening. Currently, the market has priced in a 15-basis point tightening for the upcoming meeting next month.

However, this pricing could swiftly change due to the ECB's primary focus on maintaining price stability. The release of German inflation data today holds the potential to reshape expectations regarding ECB actions. Recently, there has been an acceleration in the North Rhine-Westphalia Consumer Price Index (CPI) on an annual basis, which could signal a stronger national reading than anticipated. North Rhine-Westphalia, being the most populous state in Germany, often serves as a reasonable indicator of the overall national trend. Today, the preliminary eurozone CPI data will also be published.

The ECB's meeting in September will additionally consider evidence of potential upward risks in energy inflation. The TTF natural gas price has exhibited increased volatility and a heightened sensitivity to supply-side developments. A strike at an Australian natural gas facility and reduced imports into Europe have led to price spikes. While the TTF contract recently corrected from its peak, there are indications that prices have bottomed out and risks may shift in the opposite direction.

Risks related to food prices have surged as well. India's decision to ban non-basmati rice exports due to adverse effects of heavy rainfall on crop yields, along with Russia's withdrawal from the Black Sea grain deal, is expected to drive prices higher. The potential impact of El Nino, which is predicted to bring extreme heat and further disrupt food supplies, has been highlighted as an additional risk by the Financial Times.

The finely balanced nature of the ECB's policy decision could contribute to the swift rebound of EUR/USD. While the weak US data played a pivotal role, the likelihood of the ECB altering its rhetoric and considering rate hikes remains considerable. Presently, it's expected that the ECB will adopt a pause in its policy, thereby exerting downward pressure on EUR/USD over the short term. 

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