US payrolls to determine if the Fed hikes in June

The big news on Thursday is that the ‘Fed whisperer’ otherwise known as Wall Street Journal journalist Nick Timiraos, has published his latest article, which suggests that the Federal Reserve will pause from hiking rates in June and instead will resume rate hikes later this summer. When Timiraos writes about what the Fed may do next, the market sits up and listens since he is known to have the ear of the Fed, and they have used him in the past to deliver messages about their next policy actions to the financial markets. Thus, unless we get a blowout Payrolls report on Friday, then, according to Timiraos, we can expect the Federal Reserve to hold fire when they meet on 14th June.

Payrolls expected to cool

This report has had an immediate impact on US interest rate expectations. On Wednesday, there was a near 60% chance of a 25bp rate hike in June, however, on Thursday this probability has dropped sharply, with only a 32% chance of a rate hike priced in, and a near 70% chance of rates staying steady at 5-5.25%. Of course, this will all change if we get a blowout payrolls report for May, however, that is not what the market is expecting. The market is expecting payrolls to rise by 190k for May, which is below the crucial 200k mark, and would probably be enough to keep the Fed on hold when they meet later this month. It is worth noting that the standard deviation between the April forecast reading and the actual reading of NFPs was 0.61, thus, while there is a chance that the actual figure could be significantly different from the forecast, it is not that likely. In our view, we would need a 300k + reading for payrolls for the Fed to hike rates in June.

Fed comms and the dollar

It is worth noting that the rapid re-pricing of interest rate expectations has had an impact across asset classes. The dollar is down a touch on Thursday, the dollar index is down 0.2% at the time of writing and is clinging onto the 104.00 support level. If we see a weaker than expected payrolls report, then we may see even larger losses for the dollar. US 2-year bond yields are relatively unchanged, after all, even if the Fed does not hike rates this month, there is a high chance that they will hike rates later in the year. The market now expects a near 50% chance of a 25bp rate hike in July, with a 13% chance of a 50bp rate hike. The terminal rate remains 5.25-5.5%, which is roughly what the market expected before the WSJ article.

Prepping the market

Interestingly, US stock markets are up only a touch on this news. We may see muted trading in stocks on Thursday, as the market waits for the payrolls report. Other parts of the payrolls report to watch include the unemployment rate and wage data. The market expects the unemployment rate to edge up to 3.5% from 3.4% in April, and for annual hourly wage growth to fall a notch to 4.4% from 4.5%. It is worth noting that trends in the unemployment rate and the growth in hourly wages tend to be slow moving, thus the focus is likely to be on the headline payrolls number, unless we get a major shock in wage data or the unemployment rate. If payrolls are in line with expectations, then we could see the Fed shift to a model where they are hiking at every other meeting, according to Philadelphia Fed President Patrick Harker. He has also said that there is clear evidence that labour market imbalances are easing, and that inflation is moving in the right direction. Added to this, Fed President Powell also set the stage for a pause when he spoke last month, saying that the Fed needed to assess the impact of 10 straight rate hikes before making its next move. Thus, the WSJ article is a way to prep the market, rather than surprise them in June.

Elsewhere, the last few US companies reporting earnings for Q1 include Macy’s. Its shares plunged on Thursday, as it cut its full year earnings guidance and warned of weak discretionary spending trends that could worsen by the end of the year. Although earnings beat expectations, the future guidance was everything, and the weak forecast sent the share price plunging by nearly 10% in pre-market trading. On a board basis, this earnings report highlight the challenges facing the US consumer, and thus US growth, later this year,

UK:

In the UK there was some good news for the Bank of England. It reported that companies were moderating their pricing intentions over the coming year. The BOE’s decision makers panel found that businesses were expecting to raise prices by 5.1% in the next year, down from 5.9% in April. While this suggests that inflation could fall from its current rate, these price intentions are still well above the BOE’s 2% target rate, which makes further BOE rate hikes likely. UK house prices have also fallen further, as the impact of 12 consecutive rate increases starts to bite. Nationwide reported that house prices declined 3.4% compared with a year earlier. Data from the BOE also showed that mortgage lending also fell by $1.4bn in April and we expect that to fall further in May on the back of the bond yield spike that happened in mid-May after the April inflation report. This all suggests that headwinds to the housing sector look set to continue, and since the consumer wealth effect can be directly linked to the value of homes, then this data suggests that consumer confidence could take another knock. With rising interest rates and the prospect of more people having to remortage at higher rates of interest in the next 1-2 years of the refinancing cycle, this could be bad news for growth. However, healthy levels of income growth and a low unemployment rate could mean that mortgage arrears levels remain low, even if house prices fall further. Overall, UK data released this week is bad for the pound, however, the FTSE 100 is driven more by international factors and could be resilient to changes in the UK economic environment, the blue-chip index is up some 0.4% on Thursday.