Markets
Markets have been counting down to US payrolls data for June, which could shape further expectations of Fed tightening and its implications for financial conditions globally. Meanwhile, the yield curves in Japan, the UK and Europe have begun to steepen, a development that initially began during the previous sessions. The short end of the curve is clearly “better protected” with recent comments by policymakers at the European Central Bank and the Bank of England suggesting that lower oil prices provide time to assess next policy steps. German returns It rose between 2 basis points (2 years) and 4.5 basis points before the US payrolls report. to UK and Japanese yield curve This was respectively +2 basis points (2-y), 6 basis points (30-y), and minus 0.6 basis points and +5.7 basis points (30-y). The Japanese government bond movement was boosted by an uninspiring auction of 10-year Japanese government bonds. It is clear that investors are still demanding higher premiums as the Japanese government aims to pursue a supportive fiscal policy to drive (nominal) GDP growth. At the same time, it wants the Bank of Japan to join (or at least not oppose) this policy ambition. The rise in long-term bond risk premia this time has not hurt currencies such as the pound or the yen. After touching a 40-year high (weakest relative to the yen) at 162.84 USD/JPY yesterday, the pair fell to the 161.4 area ahead of the payrolls release as markets apparently fear imminent interventions (eg in the context of weak market liquidity when US markets close tomorrow). Sterling also rose, extending yesterday’s break below the bottom of the 0.86 range that has been the floor of the trading range in the business for almost a year. EUR/GBP was trading near 0.856 ahead of the payrolls release. The euro also slightly outperformed the dollar but lost against the yen and the British pound.
Clearly, these moves still need to be validated by the reaction to the US payrolls report. After three strong monthly reports on the US economy In June it created only 57,000 net jobs, on top of a negative revision of 74,000 jobs in the previous two months. This decline was mainly due to the sudden decline in the leisure and hospitality sector (-61K, possibly due to World Cup impacts). Professional business services (+36K) and special education and health (+69K) contributed positively. There was also a marginal rise in manufacturing jobs (+3K). The unemployment rate (derived from the Household Survey) fell from 4.3% to 4.2%, but “for the wrong reason.” Employment in this survey fell by 507K, but less than the decline in the labor force (-720K), indicating lower participation. Average hourly earnings were as expected at 0.3% per month and 3.5% per year. The strong fluctuations in the household survey will likely not go unnoticed by Fed Chair Warsh as the Fed takes a look at the accuracy/reliability of the data. However, the US yield curve is steepening with the two-year bond yield falling by 4 basis points. The 30-year level still adds about 2 basis points. Markets now see only a 20% chance of a rate hike in July (from around 30%). The 25 basis point move is now only fully discounted by December. The reaction of yields in EMU/Germany and the UK was only marginal compared to pre-payroll levels (1-2 basis points lower at the short end of the curve). The dollar is facing a setback. The DXY index is falling from the 101.2 area and is currently trading near 100.8. EUR/USD rebounds to the 1.1445 area. Even the yen continues its intraday gains against the dollar, trading near the $161/JPY level. The stocks have a “diminished opportunity” due to tightening financial conditions. The Eurostoxx 500 rose 1.3%. The S&P survived a negative open (+0.3%).
News and opinions
Germany’s government coalition overcame weeks of friction to agree on a wide-ranging reform package aim to – Reviving long-term economic growth potential and Social welfare, retirement system and labor market reform. It also includes support for vital sectors such as artificial intelligence, semiconductors and batteries. It also provides an annual tax break of €10 billion to families with small to medium incomes. Discussions on the final 34-point package got an important boost last week when coalition partners largely agreed on pension reform while still far apart on tax cuts. Conservatives in the CDU have long resisted funding it (in part) by imposing a higher tax rate on those with higher incomes. The legislative scheme is supposed to develop into a comprehensive plan by the parliamentary summer recess, which begins at the end of next week.
Swiss inflation remained stagnant in June on a monthly basis, allowing the annual figure to fall from 0.6% to 0.5%. Core CPI defied an expected rise to 0.4% by matching May’s reading of 0.3% year-on-year. Prices for fruit and stem vegetables, hotels and other accommodation providers have risen, as have car rental and car-sharing prices. This was offset by lower prices, especially for energy-related products. The recent weakness of the franc does not appear to have peaked yet with imported inflation falling by 0.4% month-on-month, rising by just 0.2% year-on-year. The EUR/CHF pair traded flat on the release before falling to the 0.92 level, but the pair bounced back to trade slightly lower on the day around that high number. Swiss financial markets continue to lean towards raising interest rates rather than lowering them from zero. The implied probability of such a move this year is low (about 25%).
