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Great Jobs! - The Week Ahead

FICC Podcasts 06 août 2021
FICC Podcasts 06 août 2021

 

Disponible en anglais seulement

Ian Lyngen and Ben Jeffery bring you their thoughts on the U.S. Rates market for the upcoming week of August 9th, 2021, and respond to questions submitted by listeners and clients.


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About Macro Horizons
BMO's Fixed Income, Currencies, and Commodities (FICC) Macro Strategy group led by Margaret Kerins and other special guests provide weekly and monthly updates on the FICC markets through three Macro Horizons channels; US Rates - The Week Ahead, Monthly Roundtable and High Quality Credit Spreads.

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Ian Lyngen:

This is Macro Horizons, episode 132. Great Jobs! presented by BMO Capital Markets. I'm your host, Ian Lyngen, here with Ben Jeffery to bring you our thoughts from the trading desk for the upcoming week of August 9th. We're reminded that while hiring might be trending, unfortunately, so is Delta, and not the little triangle.

Speaker 2:

The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates, or subsidiaries.

Ian Lyngen:

Each week, we offer an updated view on the U.S. rates market in a bad joke or two. But more importantly, the show is centered on responding directly to questions submitted by listeners and clients. We also end each show with our musings on the week ahead. Please feel free to reach out on Bloomberg or email me at ian.lyngen@bmo.com with questions for future episodes. We value your input and hope to keep the show as interactive as possible. So that being said, let's get started.

Ian Lyngen:

In the week just past, the Treasury market, had a variety of new information to digest, the most notable being the stronger than expected non-farm payrolls report. The figures showed a 943,000 job increase in the U.S. employment profile, of that 240,000 jobs came from the government sector. The vast majority of which was a function of the seasonal adjustments associated with education hiring. This only slightly detracted from the overall magnitude of the number, the private non-farm payrolls print was 703 effectively in line with expectations.

Ian Lyngen:

Now the unemployment rate did drop more than anticipated and the labor market participation rate increased, but only slightly and remains at relatively subdued levels given where we are in the cycle. The week also included two extremes in terms of price action. 10 year yields got as low as 1.126, and then retrace to 130, which is a 200-day moving average. The market appears to be stabilizing in this range as the counterforces of an extended path out of the pandemic versus ongoing improvements in the real economy continued to dominate the market narrative. We also had a disappointing ISM manufacturing print, more than offset by a stronger than expected ISM services number. In fact, ISM services was the highest on record and is very consistent with the notion that reopening will bring with it service sector optimism, and this will help drive the economy to the next plateau.

Ian Lyngen:

We're somewhat skeptical given that this is all information from July and the bulk of the Delta variant concerns really didn't start to take hold until the last couple of weeks. As for the momentum profile in the Treasury market, we were leaning very bullishly at the beginning of the week with lower rates, the obvious path of least resistance. Stochastics have since curled and crossed, and now favor a retracement back into a slightly higher yield range. For context, we'd find it difficult to see 10-year yields above 142, but for the time being at least an attempt to fill the gap in 10-year yields between 109 and 110 appears to be on the back burner.

Ben Jeffery:

Well, Ian, I think another NFP print at nearly a million jobs added seems like a reasonable place to start today?

Ian Lyngen:

It's great place to start, but I'm more worried about whether or not it's where this trend is going to end? The refocus of market participants on the Delta variant has already made the July non-farm's payroll print stale information. The question in my mind is what happens over the course of the summer are returned to work plans delayed? And if that's the case, will we see a pause in the rehiring efforts as potential employers reevaluate their staffing needs? One thing that is clear is when we combine the upward revisions to the last couple of months, we got well above a million jobs added in the U.S. economy.

Ben Jeffery:

And while yes, Delta uncertainty during the survey week was not nearly as pronounced as it is now, what this suggest is not nearly a move backwards in terms of a return to a new normal, but rather a lengthening of the time horizon it will ultimately take to see staffing levels in urban offices, for example, returned to the levels that will ultimately define the post pandemic world. So not related to those types of jobs specifically, but rather the type of service employment that relies on those commutes, those offices being staffed. It's those hiring plans that could potentially now be delayed, at least marginally, which really serves to extend the runway that will be required to more completely undo the damage on the labor market that was a function of COVID-19 and bring the participation rate up. Now that rose in July, but still remains well below levels where the fed would ultimately like to see it.

Ian Lyngen:

And on the topic of the participation rate, this is one area that we continue to focus on as we learn more about the employment landscape. For the inflation that we have seen thus far to become self perpetuating, we will need to see more wage gains make their way through the system and become sustainable. We did have a higher than expected average hourly earnings print for July, which brought the year over year pace up to 4%. certainly high by recent standards although clearly a reflection of pockets of labor scarcity as many sideline workers remain reluctant to re-engage with the labor market.

Ben Jeffery:

And on that topic, we recently looked at the JOLTS survey, which reinforces this idea of a unique variety of labor scarcity. Job openings and outright terms continue to climb and we've also seen the quits rate pick up substantially. So what this suggests to me is that not only are employers having to pay up to fill job openings with people who were previously unemployed, but there's also apparently a difficulty in retaining current workers given the fact that opportunities are so plentiful, that people are clearly very willing to leave roles in order to seek what is presumably higher compensation.

Ian Lyngen:

And that might be the next trend that ultimately defines the path out of the pandemic. First, we had the surprising increase in risk asset valuations then we had the more intuitive rise of home prices, particularly outside of non-densely populated urban centers. And now paying up for frontline service sector, employees appears to be trending.

Ben Jeffery:

So this then begs the question is the Fed running the risk of getting too far behind the inflation curve if their new operating framework implies that they'll be comfortable with consumer prices above target for some time? So the unknown is have we reached that point? We did hear from Vice-Chair Clarida this past week and he said he could envision a world in which the economic conditions for liftoff were met by the end of 2022, and he sees liftoff taking place in 2023. So at least from one core member of the FOMC, it seems as if another year and a half with elevated inflation will satisfy the criteria of bringing average inflation around the 2% target following what was a very extended period of time with core prices running below that level.

Ian Lyngen:

And there's also the employment aspect of it. Yes, the fed wants to have inflation come back into the system in a sustainable demand-driven way, but it's also a key mandate to promote employment. Whether it is a fed story or an inflation story was one of the key takeaways from the price action that followed nonfarm payrolls. If it had been a fed story, we would have expected the belly of the curve to lead the sell off, particularly the five-year sector, as well as higher rates in Euro dollars. Instead, what occurred was a bear steepner led by tens and thirties. So this tells us two things. One is it suggests that there's a supply concession because there'll be a big seller of 41 billion tens on Wednesday and 27 billion thirties on Thursday i.e the Treasury department. The other takeaway was it is an inflation story if the fed isn't going to respond to higher realized inflation. And another takeaway from what the vice chair told us was they're not hiking rates in 2021 or 2022.

Ben Jeffery:

And that will leave attention on Wednesday morning CPI release. To evaluate the degree to which those pandemic specific pickups and inflation have become more broad-based. Auto prices are going to be a clear area of focus, but there's also the travel and entertainment subset of consumer prices that clearly benefited asymmetrically from the reopening of the economy. And really in contemplating the question, what will define not transitory? It will need to be a function of that self perpetuating wage-driven dynamic you mentioned earlier, Ian, or a more complete rise in prices that's not simply focused in a few specific areas.

Ian Lyngen:

You asked the question, what will it take to no longer be transitory? All counter with who will it take to no longer be transitory? And in that context, the definition of transitory will always be owned by the fed. So it's the point in which the fed starts to suggest that what we are seeing are rises in consumer prices that have either gone far beyond what the fed is comfortable seeing, or the fed chooses to take a lighter approach to the new framework.

Ian Lyngen:

One of the key debates in the market following the June FOMC meeting was precisely how committed the fed was to allowing inflation to run hot for a sustainable period of time? Another stronger than expected core CPI print for July will refocus investors on this topic. And again, as with the response following the non-farm payrolls print, we'll be watching what happens in the belly of the curve versus the long end outright.

Ben Jeffery:

And while Wednesday and Thursday is 10 and 30-year refundings surely contributed at least on the margin to the post jobs price action, it's also worth touching on what we learned from the refunding announcement itself. Namely that the Treasury department is preparing to start trimming coupon auction sizes as soon as November given the developments and issuance needs that have come alongside the passage of the pandemic and the fact that another crisis level fiscal bill will not need to be funded. So while theoretically, that wording leaves the door open to February coupon cuts, at this point, the consensus generally seems to be that coupon auction sizes are going to be trimmed beginning in November. On the issue of the SOFR-FRN, we did learn that the Treasury department has concluded its study of the topic, but the extent on the clarity of whether it will be issued was limited to the Treasury department will continue to debate whether or not the new product is necessary to fund the deficit

Ian Lyngen:

In parsing the price action, it's worth highlighting the record high equity prices once again, at the same time that 10-year yields managed to dip as low as 1.126, or essentially the lowest levels that we have seen since February. It's a reasonable question to ask if risk assets are operating on a different market narrative than U.S. rates. Although that's not our baseline assumption, what we suspect is underlying the price action, particularly in treasuries was a bit of a capitulation, some position squaring that has brought the Treasury market back to a lower rate plateau. While some of the economic headwinds represented by the Delta variant bring into question how aggressively the fed will ultimately choose to be once they reached the liftoff rate hike point?

Ben Jeffery:

And, Ian, you bring up a really good point on the dynamics around the price action itself that we've seen lately. After 10-year yields got to 177 at the end of March in each subsequent bearish episode, the bar to buy the dip has been lowered owing in no small part to the positional landscape. First we saw tens reached 177, then we saw tens reach 170, then we saw tens reach one 50. And ultimately the top of this latest trading range is 142. So this leaves the focus on how far yields we'll be able to back up again before investors who have been waiting for that buying opportunity, ultimately step in and limit the sell off?

Ian Lyngen:

So, Ben, when you say buy the dip, don't be the dip, you're not just talking about it equities anymore?

Ben Jeffery:

I never said that.

Ian Lyngen:

Sold!

 

In the week ahead, there are two primary factors that we expect to be particularly influential in setting the outright level for U.S. rates. The first is core CPI, expectations are for a month over month print of four-tenths of a percent. We've been focused on the composition of the upside surprises in core CPI thus far, and the market will be on guard for any broadening of the categories in which we see inflation emerging especially as the transitory debate continues. The other factor is the August refunded. All loads being equal, we'd expect to see a further outright concession ahead of tens and potentially thirties. We'd look to come out of the auction process long duration as we continue to hold to our range trading thesis as the month of August plays out.

Ian Lyngen:

We've yet to see any version of the summer doldrums really take hold in the Treasury market perhaps with the exception of a couple of slow Mondays. As Labor Day approaches, however, and there are fewer fundamental inputs to drive trade in direction, we do expect to see a drift lower in volumes as well as the implied conviction behind any move. Choppy price action during the late summer period is a very typical assumption in the U.S. rates market, and we see very little reason to fade that at this stage. The one caveat is Chair Powell at Jackson Hall. There's so much market emphasis around gaining some type of clarity as related to the tapering process that it's difficult to imagine that Jackson Hall doesn't represent a meaningful event risk if for no other reason than it will be the final tradable Fed event in Delaware into the audit.

Ian Lyngen:

The transition back to trading the details of the pandemic, certainly complicate path forward for Treasury yields, particularly as the market was just beginning to get context for the magnitude of the moves in the economic data. Now with the focus on the Delta variant, investors we'll take a step back and once again, discount the incoming economic data as all the information and look forward to a point where the real economy has made sufficient progress towards achieving what will be the new normal. We've reached a point in this week's episode where we'd like to offer our sincere thanks and condolences to anyone who has managed to make it this far. And as so many things have changed this year, we cannot help but wonder is it now the doge days of summer or just a doge day afternoon? Well, one thing is for sure, it's a doge market.

Ian Lyngen:

Thanks for listening to Macro Horizons. Please visit us at bmocm.com/macrohorizons. As we aspire to keep our strategy effort as interactive as possible, we'd love to hear what you thought of today's episode. So please email me directly with any feedback at ian.lyngen@bmo.com. You can listen to this show and subscribe on Apple podcasts or your favorite podcast provider. This show and resources are supported by our team here at BMO including the FICC macro strategy group and BMO's marketing team. This show has been produced and edited by Puddle Creative.

Speaker 2:

This podcast has been prepared with the assistance that employees of Bank of Montreal, FEMA, as the burned incorporated and BMO Capital Markets Corporation. Together, BMO who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts. Not withstanding the foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including without limitation, any commodities, securities, or other financial instruments.

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Speaker 2:

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Ian Lyngen, CFA Directeur général et chef, Stratégie de taux des titres en dollars US
Ben Jeffery Spécialiste en stratégie, taux américains, titres à revenu fixe

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