09 Apr 2024
The US labour market showed another strong performance, with non-farm payrolls increasing by over 300,000 in March, building on the February outturn and ahead of the consensus expectation of 215,000.
The jobless rate dropped to 3.8% from 3.9% and the annual growth in hourly earnings came in at 4.1%, both as broadly forecast. The largest job gains were in healthcare and government, sectors less sensitive to the economic cycle; it is clear that government spending is playing a part in providing an economic stimulus. But there was good jobs growth in services and construction, indicating a broader improvement.
This data reduces the chances of Federal Reserve (Fed) easing policy in the near term, with market pricing of rate cuts now showing a distinct skew towards the latter part of the year; only three cuts are now priced in by early 2025. Inflation remains the biggest determinant of where rates go but the robustness of the US economy will allow the Fed more time to assess whether price trends are moving in the right direction.
There has been mixed news on the inflation front in recent weeks. Oil prices have firmed on heightened tensions in the Middle East and signs of stronger economic activity. With oil prices now above $85 / barrel, compared with nearer $70 at the turn of the year, businesses will be faced with higher costs. More positively, ‘supercore’ inflation may be set to move lower. This measure strips out housing and is judged as a good measure of inflation arising from labour sensitive components. Whilst employment data remains robust there are signs that the rate at which people are leaving their jobs voluntarily has slowed. The so-called ‘job quits’ rate has been a good indicator of the path for nominal wage growth, with higher readings associated with strong wage growth. To back this up, the latest ISM Services Prices Paid fell to a four-year low in March. Oil prices back at $100 would cause concern for the Federal Reserve, but current domestic trends look broadly favourable.
Looking at the major bond markets there has been a significant change in the expected timing of rate cuts since the beginning of the year. Back in December the US was expected to be the first major central bank to cut, followed by the European Central Bank (ECB) and then the Bank of England (BoE). Now, of these three, the Fed is priced to act last and the leader’s baton has been handed to the ECB. This reflects the different growth profiles seen in the euro area and the US. In the UK, rate cut expectations have been scaled back but the BoE is still being priced to deliver a cut before the Fed.
One measure that has signalled tougher economic times ahead has been money supply growth. A common global feature was a surge in broad money arising from the pandemic, followed by a steep decline. In the UK ‘M4’ growth, recognised as a good measure of money supply, has been negative for some time and dipped to a low in September 2023, coinciding with a shallow recession. But there are now tentative signs that M4 is on the mend. This is another indicator that the current interest rates are being accepted and that consumer and business are adjusting to a new environment.
In markets, 10-year US treasury yields moved higher on the non-farm payroll data, settling above 4.4% for the first time since November 2023. In the euro area, 10-year German yields rose 10bps to end at 2.4%, a move reflected in the UK where 10-year rates finished above 4%. From my perspective, current yields look attractive, with US nominal and inflation protected bonds the stand outs.
In credit market, spreads were not much changed. Sterling investors were occupied by the troubles at Thames Water, where the holding company announced a default on its 2026 bonds. In addition, the debt of the regulated Thames Water operating company was downgraded by the rating agency S&P to BBB-, the lowest investment grade rating. In their review they noted that investment grade ratings were part of Ofwat's considerations when deciding on water companies' licenses, and that they expected that the various parties would constructively seek a mutually acceptable solution. The credit spread on the recently issued 20-year Thames Water Utility debt widened about 30bps on the news flow, equating to an approximate 3% price decline. Whilst this indicates greater concern about the health of the Thames Water utility, the muted impact on price also reflects the nature of the protections offered by operating company debt.
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