As evidence mounts to support the contention that economic activity in the US is leveling off, July payrolls looms especially large on the data horizon.
The next jobs report is, for all intents and purposes, a giant question mark. It won’t capture the most recent deterioration in the labor market, but it could reflect some of the economic impact from reinstated containment protocols in states experiencing COVID-19 flare-ups.
The Trump administration and the market would like to see an encore after blowout reports in May and June, but flagging consumer sentiment, stubbornly high jobless claims, and anecdotal reports of small business despair suggest another blockbuster is not a foregone conclusion. And even if it were, we’d still be far from pre-pandemic levels of employment.
Negotiations around the extension of extra federal unemployment benefits (and other sticking points on the next virus relief package) continued over the weekend. “There’s still a lot of work to do”, Steve Mnuchin sighed after Saturday’s talks.
The market seems to believe a compromise is the most likely outcome — something between the GOP’s proposal to slash the federal supplement to $200/week until states are able to implement systems facilitating 70% wage replacement, and Democrats’ aim to keep the federal assistance at $600. As Bloomberg Intelligence notes, “an agreement on a $400 add-on would be consistent with… annualized third-quarter GDP growth at 17%”.
In the extremely unlikely scenario that no agreement is reached and the entire federal supplement simply disappears, Bloomberg Economics warns that “would be the equivalent of erasing the average wage income of over 15 million Americans”. If that were to happen, you can wave goodbye to the sharp recovery in consumer spending.
Even as equities prove resilient amid disconcerting labor market signals (figure below), rates are telling a bit of a different story.
“Having established 51.9 bp as the level to beat in 10s, the balance of the summer has just become a bit more intriguing given the potential for a breakout to retest the 31.4 bp record low”, BMO’s Ian Lyngen said Friday, adding that while it’s not his baseline scenario, “it’s now much more likely” than when the benchmark was content to ply a narrow range between 60 and 70 bp as the market “look[ed] past some of the fresh rounds of lockdowns and slowed re-openings”.
It will be harder for 10s to look past a downside surprise on payrolls next week, and traders will be keen to see if claims log a third consecutive weekly rise when the latest numbers come in on Thursday.
“With the 10-year at 54 bp, where we go from here is the key question”, SocGen strategists including Subadra Rajappa wrote Thursday.
“Although the 10-year will likely struggle to break through the historical low, weak July employment data or large downward revisions to prior months might be the catalyst for a further rally from here”, they went on to say, before reiterating their expectations for the curve to retain a flattening bias.
Note that we’re coming off the biggest monthly flattening for the 5s30s since 2017.
“Developments at the far end of the curve have turned technically interesting over the past weeks as substantial technical damage has been done for bond bears”, Nordea’s Andreas Steno Larsen remarked on Friday, flagging the same downside technical break in 10-year yields, before underscoring the notion that while “rates remain reactive to the macro environment and stalling high frequency data, it is more debatable whether equities listen at all”.
Yes, that is debatable. And it’s no secret why stocks are “deaf”, so to speak.
“While acknowledging that they have little power to revive the economy, central banks have no choice but to maintain maximum monetary accommodation”, SocGen said. That policy stance is helping to suppress real rates, which in turn supports risk assets. Remember, it was surging real yields which ultimately choked off the rally in 2018.
While deeply negative real rates are putting pressure on the dollar and driving up precious metals, they are a sign of success for the Fed as long as they’re accompanied by a slow drift higher in breakevens.
For now, this is a benign backdrop for risk assets, and Fed policy is “going to push up anything that’s priced in dollars”, Bloomberg quotes JonesTrading’s Mike O’Rourke as saying late this week. “So obviously that’s helped equities”, he added.
Yes, “obviously”. The question is whether, with a daunting seasonal upon us and the economy poised to stall, this delicate balance can be maintained. As noted earlier Saturday, if the growth outlook were to deteriorate suddenly and significantly, or if some other factor (e.g., another plunge in oil) were to come along and drive breakevens sharply lower, it would be difficult for the Fed to act quickly enough to prevent a spike in real yields.
For now, I suppose we should all just relax and enjoy the everything rally (figure below).
Who knew a pandemic would be seen, in hindsight, as just another dip to buy.
“Domestic equities apparently have sufficient antibodies to ward off the building economic pessimism evident in US rates”, the above-mentioned Ian Lyngen said, in the same cited note. “Or perhaps it’s the distance and the mask, but we digress”.