12/05/2021 | News release | Distributed by Public on 12/05/2021 20:14
Markets are still digesting last week's jobs data. It's been analyzed to death already but suffice to say that the headline weakness belies underlying strength in the labor market. We are closer to full employment than we thought (see below) even as price pressures continue to rise (see below). Fed officials are sounding increasingly hawkish despite the risks from omicron. As a result, we believe the Fed is likely to announce a faster pace of tapering at the December 14-15 FOMC meeting. This is unequivocally bullish for the dollar. Because of the media blackout, there will be no Fed speakers until Powell's post-decision press conference December 15.
Indeed, Fed tightening expectations remain elevated despite the mixed jobs report. WIRP suggests Q2 liftoff is nearly fully priced in, with another 1-2 hikes priced in by end-2022. Looking further out, swaps market is pricing in a little over 50 bp of Fed tightening over the next 12 months and about 125 bp over the next 2-3 years. A terminal Fed Funds rate of 1.5% seems too low to us if the labor market is getting as tight as we fear. Obviously, a lot depends on omicron and other possible variants that pose downside risks to the economy. However, the market seems a bit complacent about Fed tightening. If we had to pick a side, we think the risks are tilted for a terminal rate above 1.5%, not below. Of note, Fed Funds peaked at 2.25-2.50% back in 2019 before the mid-cycle correction saw three cuts that year to 1.50-1.75%, while the Dot Plots show the median long-term rate at 2.5%.
November CPI Friday will be the data highlight. Headline inflation is expected at 6.7% y/y vs. 6.2% in October, while core (ex-food and energy) is expected at 4.9% y/y vs. 4.6% in October. If so, headline would be the highest since June 1982 and core the highest since June 1991. Of note, average hourly earnings only rose 4.8% y/y in November vs. 5.0% expected. The Fed Beige Book warned of robust wage gains across most Fed districts and so we expect this series to continue ticking higher, especially with the labor market remaining tight.
Markets for now believe that the Fed has things under control. The 10-year yield traded as low as 1.33% Friday, the lowest since late September. Elsewhere, the 10-year breakeven inflation rate is trading around 2.44%, the lowest since early October. On the other hand, the 2-year yield traded at a new cycle high of 0.65% Friday, reflecting heightened Fed tightening expectations. The 2-year differentials with Germany and Japan should continue to rise in the dollar's favor.
Weekly jobless claims Thursday are worth watching. Initial claims are expected at 225k vs. 222k the previous week and continuing claims are expected at 1.91 mln vs. 1.956 mln the previous week. As we noted last week, the four-week moving average for initial claims is now 239k, the lowest since March 2020. If we get a couple more readings near 200k, that 4-week moving average will be pulled lower to levels we haven't seen since 2019 and 2020, when the U.S. was last at full employment. Bottom line: we are closer to full employment than we thought and that will likely start showing up even more in the wage numbers.
Otherwise, it's a very quiet week for the U.S. in terms of data. Q3 nonfarm productivity and unit labor costs, October trade (-$66.9 bln expected), and consumer credit ($25.0 bln expected)will be reported Tuesday. October JOLTS job openings (10.5 mln expected) will be reported Wednesday. October wholesale trade sales and inventories and Q3 household net worth will be reported Thursday. Preliminary December University of Michigan consumer sentiment (68.0 expected) and November budget statement (-$195.0 bln) will be reported Friday.
Bank of Canada meets Wednesday and is expected to keep policy on hold. After last week's monster jobs number, BOC liftoff expectations have risen. While the odds of a hike this week are low, WIRP suggests there's a nearly 2 in 3 chance for a January 26 hike, while March 2 is more than fully priced in followed by two more hikes in Q2. Current BOC forward guidance is Q2 liftoff and after the strong data, the bank this week may again have to acknowledge risks of an earlier liftoff. At the last meeting October 26, the bank changed its forward guidance and saw the output gap closing in Q2 22, moving up from H2 22 previously. The swaps market is now pricing in more than 125 bp of hikes over the next 12 months, which is very hard to reconcile with the new forward guidance. Ahead of the decision, October trade and November Ivey PMI will be reported Tuesday.
Eurozone has a quiet week. Germany reports October factory orders Monday and are expected at -0.3% m/m vs. 1.3% in September. German October IP (0.9% expected) and December ZEW survey will be reported Tuesday. German October trade data will be reported Thursday. Exports are expected to rise 0.8% m/m vs. -0.7% in September, while imports are expected to rise 0.4% m/m vs. 0.4% in September. German data have been weakening in q4 as the pandemic resurfaced.
New German Chancellor Scholz will be sworn in Wednesday. The Merkel era draws to a close even as Germany struggles to cope with the pandemic. Cabinet choices for the three party coalition will emerge. More importantly, Scholz is tasked with choosing the next Bundesbank chief. There is no doubt that the choice will be suitably hawkish. What needs to be recognized is that the Bundesbank is but one of many eurozone central banks and most of them are in the dovish camp. Guindos, Lagarde, and Schnabel speak Wednesday. Lagarde, Weidmann, Villeroy, Panetta, and Elderson speak Friday.
The U.K. has its monthly data dump Friday. October GDP, IP, construction and services, and trade will all be reported. GDP is expected to rise 0.4% m/m vs. 0.6% in September, IP is expected to rise 0.1% m/m vs. -0.4% in September, construction is expected to rise 0.3% m/m vs. 1.3% in September, and services is expected to rise 0.4% m/m vs. 0.7% in September. Recent data have been disappointing, which has led markets to adjust the Bank of England tightening outlook. Odds of a December hike are now less than 1 in 4, but a February hike is still nearly fully priced in. MPC member Saunders, who voted to hike rates at the November meeting, said last week that "At present, given the new omicron Covid variant has only been detected quite recently, there could be particular advantages in waiting to see more evidence on its possible effects on public health outcomes and hence on the economy." Broadbent speaks Monday.
Sterling has faded along with December liftoff expectations. Sterling is trading close to the cycle lows from last week near $1.32 and a break below sets up a test of the December 2020 low near $1.3135 and then the mid-November 2020 low near $1.3105. After that is the November 2 low near $1.2855.
Japan has a busy week. October real cash earnings and household spending will be reported Tuesday. Earnings are expected at -0.5% y/y vs. -0.6% in September, while spending is expected at -0.5% y/y vs. -1.9% in September. Final Q3 GDP data will be reported Wednesday. November machine tool orders will be reported Thursday. November PPI will be reported Friday and is expected to rise 8.5% y/y vs. 8.0% in October. The economy is showing signs of softness as we moved into Q4 and so the big slug of fiscal stimulus that's coming will be welcomed. For now, the Bank of Japan will remain on hold. Next policy meeting is December 16-17 and no change is expected.
October current account data Wednesday will be of interest. An adjusted surplus of JPY999 bln is expected vs. JPY763 bln in September. However, the investment flows will be of most interest. September data showed that Japan investors were net buyers of U.S. bonds to the tune of JPY3.77 trln, the biggest monthly number since March 2020. This came after two straight months of being net sellers. Japan investors were net sellers (-JPY46.4 bln) of Australian bonds for the fifth straight month and seven of the past eight months. Japan investors were net buyers of Canadian (JPY76.9 bln) and Italian (JPY83.0 bln) bonds in September and more than reversed August's net selling.
Reserve Bank of Australia meets Tuesday and is expected to keep policy on hold and maintain its dovish tone. At the last meeting November 2, the bank abandoned Yield Curve Control but maintained its dovish tone. Rates were kept steady at 0.10% and QE was maintained at the current weekly pace of AUD4 bln until the planned review at the next meeting February 1. However, the bank pushed back against the market's aggressive tightening expectations by stressing again that it was unlikely to hike rates until 2024 at the earliest. Yet the swaps market is still pricing in nearly 75 bp of tightening over the next twelve months. We expect it to push back again this week, citing omicron as a major factor to remain cautious.