Labour markets strength continues

Labour market data in the US was stronger than expected on Friday. US Treasuries reacted accordingly with a 10 bps sell-off with Gilts and Bunds moving in the same direction but in a calmer fashion. Risk assets did not take the news too negatively. The S&P was higher on the day and spreads were broadly unchanged post release.

There is no denying that overall data was stronger than expected, lead by Non-Farm Payrolls. Therefore, at least at the margin, chances of a rate cut in June should be slightly lower. We do note, nevertheless, that not all the numbers in the release point in this direction. Chair Powell has alluded in the past to the possibility that labour markets continue to be strong with regards to job creation while at the same time not providing such a strong tailwind to wages. In fact, as recently as April 2 in his opening remarks at Stanford University, Powell discussed how stronger than expected job gains and inflation data so far this year have not significantly changed the overall picture, “which continues to be one of solid growth, a strong but rebalancing labour market, and inflation moving down toward two percent on a sometimes bumpy path”. Furthermore, he noted “Labour market rebalancing is evident in data on quits, job openings, surveys of employers and workers, and the continued gradual decline in wage growth”.

We tend to think this labour market report will not alter his views materially. Average hourly earnings increased by 0.3% MoM and 4.1% YoY, in line with expectations. The YoY measure decreased from 4.3% and if the MoM number stays at 0.3% in the next few readings then the YoY number should continue falling slowly. The participation rate also increased from 62.5% to 62.7% as did the employment to population ratio. The strong Non-Farm Payrolls number did not move three-month averages materially either. The key word might be a “rebalancing” labour market. The Fed is not looking for a weak labour market but one where supply and demand fall closer into balance. This could happen due to a decline in demand (i.e. slower job creation), an increase in supply (i.e. higher participation and employment to population ratios) or a combination of both, which we believe is the most likely scenario.

Predicting high frequency data is always a difficult endeavour, but in this cycle it has proven even harder than usual. Proof of this are the outsized revisions to past data. The Fed has taken and will continue to take decisions based on assessments of the state of the labour market, amongst other data. Non-Farm Payrolls are certainly important but there is other labour market data that is important as well, as one of the quotes in the second paragraph above suggests. Some surveys like the NFIB small business hiring plans point to a cooling off in labour markets in coming months. The Fed acknowledges this in the latest minutes when they say “Consistent with a reduction in labour market tightness, business contacts in several Districts reported an easing in wage pressures or an increased ability to hire and retain workers” or when they point out that “Participants noted that the labour market remained tight, but demand and supply in that market had continued to come into better balance.”

Markets wise, we take this report as a further indication that a scenario with no recession, no spike in defaults and one where central banks start cutting rates at some stage is the most likely one. In such a scenario, credit should outperform government bonds. The extent of the outperformance will depend on how quickly central banks can be comfortable that inflation is on a sustained downward path. Although we do believe the Fed will gain said confidence in the next few months, at the margin, the inflation and rate-cutting picture looks slightly clearer in Europe at this stage.