BMA Market Insights: Strong U.S. Jobs Data Drives Interest Rates to Ten-Year Highs

There is practically nothing stopping the Fed from hiking interest rates now. U.S. October employment data surprised to the upside, as the unemployment rate held steady near five-decade lows. Further, a pick-up in wage growth coupled with greater job participation rates all but locked in a Fed rate hike at the December 18th-19th meeting. U.S. Treasury yields across the curve jumped on the back of the data, with two-year yields hitting 2.912%, the highest level since 2008. Similarly, the longer-end rates rallied, with the ten-year closing the week at 3.214%, after climbing more than ten basis points over the week and reaching a high of 3.22%. The 30-year Treasury followed suit and also jumped over ten basis points last week, closing at 3.462%.

While many market practitioners may be happy to wave goodbye to October, given the volatility seen in the markets last month, it does not seem like November will offer much reprieve. U.S. midterm elections will be a large focus this week, to see whether the Republicans will lose control of the House and potentially the Senate, although the latter seems less likely. Once the elections pass, the market will focus on the Fed, scheduled to meet on November 7th and 8th. While a rate hike is not expected at the meeting, signals of the aforementioned December rate hike will be closely monitored.

Despite the recent robust U.S. economic data, uncertainty between U.S. and China regarding a trade agreement continues to hang over both economies. President Trump signaled prospects of a deal last week and reportedly asked his cabinet to draft a possible trade agreement ahead of the G20 summit in Argentina later this month. The market largely expects U.S.-Sino trade talks to resume at the summit.

Hence, Chinese trade data to be released this week will be keenly watched. The Purchasing Managers’ Index (PMI) data both domestically and abroad is also scheduled for the week. The PMI serves an indicator of the economic health for the manufacturing and service sectors (see more below).

I. U.S. Economic Data/Markets

U.S. October jobs data beat expectations with 250k added last month compared to projections of 188k. Key takeaways included:
- Annual wage growth picked up by 3.1%, hitting a nine-year high.
- Participation in the labor force by those between ages 23-52 is at 82.3%, the highest level since the crisis.
- The unemployment rate remained unchanged at 3.7%, a 49-year low.
- Hotels/restaurants, health-care facilities, and the manufacturers were among the top three sectors adding the most jobs.
ISM Manufacturing PMI data for October surprised on the downside with a reading of 57.7 (versus expectations of 59).
- Labor supply constraints partly contributed to the weaker data.
- Manufacturing account for about 12% of the U.S. economy.
Case-Shiller housing index indicated annual home price gains of 5.8% in August. It is the first time annual home price gains fell below 6% in a year.
Consumer confidence surges to almost a two-decade high, rising to a level of 137.9 in October, as measured by the Conference Board, the highest reading since September 2000. Market pundits attributed strong economic growth and productivity to the reading.

II. Central Banks

Bank of Japan as expected kept its key rate unchanged at -0.1% and noted it would keep “extremely” low rates “for an extended period.” The bank also kept its target rate for 10-year government yields to be at zero. More interestingly, the bank cut its inflation forecasts for the year ending in March 2019 to 0.9% from 1.1%. The bank maintained its view that inflation would not reach its target of 2% until at least March 2021.
- The bank is monitoring the impact of ultra-low rates and the downward pressure they place on financial institutions’ profitability.
- Close attention is also being paid to Brexit, U.S./Chinese trade tensions and Italy’s budget concerns as these factors may threaten domestic economic growth.
Bank of England unanimously held its key rate steady at 0.75%. Uncertainty surrounding a smooth Brexit remained a key concern. The market largely expects a rate hike mid-2019.
- The bank indicated hiking rates to 1.5% over the next three years in order to keep inflation under control. This, compared to their view three months ago that called for a 0.25% rate hike over the same timeframe to manage inflation. Stronger economic data, in particular, retail sales, in part prompted the changed outlook.
- The relatively more hawkish sentiment caused a rally in the GBP post meeting.
- BoE noted a disruptive Brexit could weaken the currency, thereby placing upward pressure on inflation and prompting the bank to raise rates. Conversely, rates may need to be cut in order to fuel growth.
- Concerns regarding global growth on the back of U.S./China trade tensions, higher U.S. interest rates and their impact on emerging economies remained.
The People’s Republic of China will issue short-term debt this week, to help prop up the yuan. The onshore yuan hit a decade low against the USD last week.
- PBOC plans to sell 20 billion (USD 2.87 billion) split between one-year and three-month tenors to the offshore market.
- The issuance is a vehicle for the bank to prop up short-term interest rates as it reduces the number of yuan available for banks to lend. It will also likely make the cost of short selling the yuan more expensive.

III. Other

German Chancellor Angela Merkel announced she will not seek re-election when her term expires in 2020. Merkel has served as Chancellor since 2005.
- While the impact of Merkel’s departure on Germany and the Eurozone more broadly is unclear, the Euro sold off against the USD on the back of the announcement, given the potential unknown risks associated with the departure.
Chinese manufacturing PMI for October surprised to the downside coming in at 50.2 (versus expectations of 50.6), the lowest level in two years. The latest round of U.S. tariffs kicked-in September, making October the first full month where the tariffs went into effect.
- Export orders contracted for the fifth straight month.
Eurozone Economics
- Economic growth drops to a four-year low rising 0.2% between July and September, down from 0.4% the previous quarter.
  - Italy’s growth was flat largely due to a slowdown in manufacturing, fueling concerns regarding the country’s economic prospects on the back of its budget crisis.
- Inflation reached a six-year high increasing 2.2% y-o-y in October, largely due to higher oil prices.
Fed proposes looser liquidity and capital requirements for large banks. Some banks may also be subjected to less frequent stress tests. Proponents for the changes noted that the existing requirements were too stringent given the characteristics of certain lending institutions. FOMC Chair Powell was among the officials who voted for the proposal.
- The potential changes include relaxing liquidity coverage ratios requirements by 70-85% for certain institutions with $250 billion to $700 billion in assets.
- The proposal categorizes large lending institutions in four groups based on size and other risk factors. The changes target lenders such as Capital One and U.S. Bancorp and less so the very large banks such as JP Morgan.
The Alternative Reference Rate Committee, ARRC, convened to find a replacement for LIBOR, issued a timeline for milestones accomplished and its goals through 2021.
- The committee also produced an FAQ addressing new issuances of floating rate notes, where it was noted that ARRC will likely recommend a spread adjustment between LIBOR and SOFR (LIBOR’s likely replacement).
  - The spread adjustment would try to address the bank’s credit risk premia embedded in LIBOR, which is not a component of SOFR, and make adjustments for other differences between the two indices, including a transition from a term rate to an overnight rate (if applicable). The ARRC plans to conduct a market consultation on this spread adjustment to garner views of market participants.