The market's biggest near-term bet is about to face its sternest test to date Friday, with a U.S. jobs report that could either cement expectations of multiple rate cuts from the Federal Reserve, or flip growth and inflation forecasts towards a more bullish second quarter for the world's biggest economy.
U.S. employers likely added 185,000 news jobs to the economy last month, according to the median Street forecast, a notable upgrade from the 263,000 tally recorded in April but essentially in-line with the monthly average for 2019. A stronger-than-expected reading, however, particularly in average hourly wage growth, is likely to snuff-out bets on a near-term Fed rate cut and push stocks lower into the final trading day of the week and beyond as focus shifts from central bank support at home to the impact of Washington's myriad trade disputes abroad.
Conversely, a softer payroll reading, which was hinted at earlier this week by a net 27,000 new jobs additions reported by ADP, the weakest ten years, and muted wage gains could add further pressure on the Fed to ease rates into the second half of the year as the trade war impact saps domestic investment and consumer demand.
"While the recent escalation in trade tensions poses clear risks for the US economy, the macroeconomic data flow has so far remained reasonably solid - particularly from the jobs market," said ING economist James Smith. "While we expect jobs growth to slow this time, we think this is likely to be caused more by supply constraints than by weaker demand."
"These shortages are continuing to put upward pressure on wages, which is one of the reasons we think markets are getting a bit ahead of themselves in pricing in a series of rate cuts in the immediate future," he added.
The change in Fed expectation has certainly been extreme: CME Group futures prices suggest a 55.7% chance of a July cut, up from just 16.6% a month ago. A September rate move is essentially fully priced in, as well, and markets are expecting the FedFunds rate to be as low at 1.75% to 2.0% by the end of the year -a fifty basis point reduction from its current level.
Those bets have added a bullish tone to U.S. equity markets, which generally rise as the so-called discount rate for the cash flows that stocks generate -- in this case the FedFunds rate -- declines.
The S&P 500, in fact, has risen more than 4.2% this week as investors reacted to signals of Fed rate cuts from Vice Chairman Richard Clarida on May 30 in New York, and Chairman Jerome Powell a few days later in Chicago.
"We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2% objective," Powell told a Chicago Fed conference on June 3.
Those remarks, as well as recent hints from both the European Central Bank and the People's Bank of China that each could ease rates over the coming months if the ongoing U.S.-China trade war were to escalate further, has not only boosted global stocks, but sparked a rally in government bonds that have taken benchmark 10-year German bund yields to a record low of -0.23% and pushed nearly $13 trillion in global debt into negative territory.
U.S. Treasury bond yields, too, are firmly pricing in Fed rate cuts, with 2-year notes trading at a December 2017 low of 1.872% and 10-year yields holding at a September 2017 low of 2.119%.
Others, however, feel the market is pressing to hard for a Fed reaction on trade, given both the wildcard elements of an agreement between the Washington and Beijing and the chance of a resolution in talks between the U.S. and Mexico that could quickly reverse expectations of a slowing global economy.
The Fed's 'Beige Book' for the month of April, noted skill shortages and and unfilled job openings across most of the country's economic regions. The National Federal of Independent Businesses, meanwhile, said nearly 40% of its members are unable to find workers for the jobs they have available, suggesting the need for higher wages -- and potentially faster inflation to follow -- into the second half of the year.
"Even in the worst case, with private payrolls close to zero, panic would be the wrong response, either in markets or at the Fed," said Ian Shepherdson of Pantheon Macroeconomics. "Single month's numbers rarely signal an unambiguous shift in the trend, and forward-looking surveys clearly point to a rebound in payroll gains by mid-summer, and perhaps before, especially if the May reading is very low."
"Looking ahead, we remain of the view that this year will see the emergence of a clear scarcity premium in wages, with (Average Hourly Earnings) growth running ahead of the sum of productivity growth and inflation," he added.