Two-Year Treasury Yields Reach Decade Highs…Fed Has Nowhere To Go, But Up

Strong August payrolls data reaffirmed that the economy is continuing its upward trajectory and gave the Federal Reserve greater reassurance to raise rates later this month. Not only did the report surprise on the upside (see below), but also indicated that wages increased – a sign of inflationary pressures. The unemployment report was the last key data point released before the FOMC meeting scheduled for September 25th and 26th. 

Given the robust data, two-year Treasury yields jumped to a 10-year high reaching 2.703%, a level not seen since July 2008. Longer-term Treasury yields also rallied on the back of the news, with the 10-year and 30-year yields reaching 2.941% and 3.101% respectively. The U.S. dollar also strengthened on the back of the data and thereby increased prospects of the Fed’s rate hikes. 

Despite the bullish jobs report, equity markets took a hit on the back of escalating trade tensions, between the U.S. and China, with technology stocks and mutlinationationals taking the brunt of the losses. The S&P 500 had its biggest weekly loss since June, ending the week at 2,871.68, after opening the week near 2,900. 

I. U.S. Economic Data/Markets

• August payrolls report surprised to the upside with 201k jobs added last month, compared to the market expectation of 190k.
  • Average hourly earnings were up nearly 2.9% from a year ago, the strongest y-o-y wage pick-up since mid-2009.
    • The pick-up wages (which had been sluggish), will prompt the Fed to hike to stave off inflation.
  • Employers added jobs for 95 straight months, the longest run ever.
  • Unemployment level remained steady at 3.9%.
• Factory sector saw the fastest expansion in 14 years: ISM manufacturing index rose to 61.3 in August, the highest level since May 2004.
  • The reading surprised to the upside as many analysts expected a slowdown in manufacturing given escalating trade tensions and that August usually is a slower month for factory activity.
  • July’s reading was at 58.1.
• U.S. trade deficit widened to the highest level in a decade, reaching $337.9 billion, up $22 billion from a year ago.
  • A booming domestic economy served as a boon for imports, while a strengthening dollar, trade concerns, and slower growth impacted demand for U.S. exports.
• Weekly jobless claims near 49-year low: claims for state unemployment benefits dropped 10,000 to a seasonally adjusted 203,000 last week, the lowest level since December 1969. 
• New York Fed President John Williams provided an upbeat economic outlook at a fireside chat last week. Williams is a permanent voting member of the FOMC. Key takeaways included:
  • The current levels of unemployment and inflation are “about as good as it gets” regarding the Fed achieving its dual mandate of maximum employment and low and stable inflation.
  • Given wage gains had not jumped up, the economy has more room to run and before feeling inflationary pressures (this fireside chat took place prior to the August jobs report released on Friday).
  • Expected unemployment rate to continue to fall.
  • Believed the Fed should not be concerned if the yield curve were to invert on the back of it raising short-term interest rates above long-term yields, as long as such actions are necessary to achieve the central bank’s targets.

II. Trade Talk

• Canada/U.S. trade talks continued, with key areas of focus including the dairy, aluminum & steel, and automobiles sectors.
  • While the week ended without a deal, Canadian officials were reportedly optimistic that a deal will ensue to salvage NAFTA by month end.
• President Trump alluded that Japan may be next on his agenda with tariffs in the auto industry as a key focus.
  • Japan is the third largest exporter to the U.S., after Mexico and China.
• China/U.S. – President Trump threatened levies on $267 billion of Chinese goods on Friday.
  • If Trump follows through on the tariffs, a total of about $517 billion of Chinese exports would face levies by the U.S.
  • China retaliated with threatening to impose $60 billion on U.S. goods.
• Brexit – Bank of England’s Governor Mark Carney indicated he will remain past his expected departure date of June 2019 to help ensure a smooth transition of Britain’s departure from the EU.

III. Other

• Bank of Canada kept its key rate unchanged at 1.5%. 
  • BoC indicated the outcomes of the NAFTA discussions with the U.S. could impact their decision going forward.
  • NAFTA discussions aside, it is largely expected that the BoC will hike at its meeting next month on the back of stronger employment and inflationary pressures.
  • Post the BoC meeting, a senior Canadian official noted that tariffs and protectionist measures could weigh on economic growth and incomes in a speech last week. An agreement with the U.S. could spur growth higher than expected. 
  • Canada’s unemployment rate increased to 6%, up from 5.8% in July, based on a report released Friday. Hourly wages also dropped to 2.9%, after increasing 3.2% in July.

Emerging Markets

• EM equities entered the “bear market” towards the end of the week (bear markets are typically defined as equities dropping more than 20% in a given market) on the back of tariff tensions and economic duress. The iShares MSCI EM exchange-traded fund (ETF) fell from its high in January of more than 20%. 
  • The iShares of the MSCI Turkey exchange-traded funds (ETFs) are down nearly 57% and ETFs representing Brazilian and Argentinian stocks were down about 34% and 33%, respectively.
• Argentina’s equity markets did pop a few points during the week on the back of more optimistic discussions between the government and the International Monetary Fund.

This week:

While a slew of key data is scheduled to be released throughout the week, two key central banks will announce their decisions on Thursday. The Bank of England and European Central Bank are largely expected to leave rates unchanged this week. The Bank of England hiked rates at its previous meeting and outside of data, the bank is focused on the outcome of Brexit negotiations in determining its pace of rate hikes. 

While the European Central Bank previously noted it will likely keep the key rate unchanged until September 2019, market participants will keenly await any actions regarding its asset repurchase program and market projections (including GDP and inflation data). A slew of negative economic releases for the region has created headwinds that may prevent the bank from curtailing QE.

Key data/events include:

• CNY CPI/PPI (Monday)
• GBP industrial/manufacturing production (Monday)
• GBP July GDP (Monday)
• U.S. consumer credit (Monday)
• CNY FDI (Tuesday)
• GBP employment/wage data (Tuesday)
• U.S. Fed’s Beige Book (Wednesday)
• U.S. PPI (Wednesday)
• AUD unemployment (Thursday)
• German Harmonized index of consumer prices (Thursday)
• Bank of England rate decision (Thursday)
• European Central Bank rate decision (Thursday)
• U.S. CPI data (Thursday)
• U.S. August retail sales data (Friday)

U.S. Economic Data includes: Consumer credit change (Monday), Redbook index (Tuesday), JOLTS job openings, wholesale inventories, PPI (Wednesday), Fed’s Beige Book, weekly jobless claims (Thursday), CPI data, August retail sales (Friday), import/export price index, industrial production, capacity utilization, Michigan consumer sentiment index, business inventories, Baker Hughes oil rig count.

Overseas Economic Data includes: CNY CPI/PPI (Monday), GBP industrial/manufacturing production, GBP trade data, GBP July GDP, CNY FDI (Tuesday), GBP employment/wage data, German ZEW survey, CAD housing starts, AUD Westpac consumer confidence (Wednesday), EUR industrial production, JPY foreign bond/equity investments, EUR EcoFin Meeting (Thursday), AUD unemployment, French CPI, German Harmonized index of consumer prices, GBP BoE meeting, ECB rate decision, CAD new housing price index, CNY retail sales (Friday), JPY industrial production, Italian CPI, EUR labor costs.