The latest US labor market report revealed unemployment rate increase of 0.29pp to 4.048% in June. The US dollar weakened substantially in the aftermath of payrolls data release as the market apparently was not satisfied with such performance. However, I believe that the market jumped to conclusion without taking a deeper look into the US labor market.
Chart 1: EUR/USD movements
Non-farm payrolls increased by 213 thousand in June and previous months’ data were revised up by a total of 37 thousand. All this together with previous months performance confirms that pace of payroll growth sped up recently (see chart below) which is consistent with the effects of fiscal expansion on the economy and expected growth acceleration.
Chart 2: Average payrolls increase
Source: St. Louis Fed
According to the minutes of June FOMC meeting, some business contacts reported that plans for capital spending had been scaled back or even postponed as a result of uncertainty regarding future trading relations between the US and its main trading partners. It must be noted that this is still not reflected in the labor market figures as employment growth in June came in line with the average increase in the first half of the year. Increase in manufacturing employment reached its highest level this year.
The unexpected rise in the unemployment rate is driven by a rise in labor force participation to 62.9%, not weaker household employment. When the labor market performs as well as it is in the US, it is not surprising that previously discouraged workers are starting to search employment again. However, participation rate (share of people available for work as a percentage of the total population at the age of 16 or older) is moving sideways for years and there is currently no reason to believe that the move in June is anything else but a one-time effect.
Chart 3: Labor force participation rate
Source: St. Louis Fed
Wage growth continued at 2.7% yoy pace in June and therefore failed to provide any new information to the market participants. Core PCE inflation recently reached 2% target and inflationary pressures in the coming period will be additionally boosted with the impacts of imposed USD50bn tariffs on Chinese imports that includes 818 different products.
I read some articles recently that suggested that some Fed officials are becoming concerned about the flattening yield curve (see chart below). While the latter was discussed among the participants, I would like to point out that I haven’t seen any official information that would imply worry or suggest that the curve flattening will have any impact on the future monetary policy decision.
Chart 4: US 2Y-10Y spread
The Fed clearly stated recently: “Commonly cited measures of the term spread, such as the difference between the 10-year and 2-year nominal Treasury yields, have dropped over the past several years, a trend that has raised concerns and provoked extensive commentary in the financial press. The current level of the near-term spread does not indicate an elevated likelihood of recession in the year ahead, and neither its recent trend nor survey-based forecasts of short-term rates point to a major change over the next several quarters.“
The EUR/USD increased in the past few days to the highest level since mid-June driven with what the market interpreted as a disappointing rise in the US unemployment rate. However, a one-off marginal increase in unemployment is not changing the fundamental drivers of the USD strength and I therefore expect that the EUR/USD will decline from the current levels in the near term. The latter remains supported with the growing interest rate differential between the US and the Euro zone as the ECB clearly stated they have no intention hiking rates before autumn 2019 and expected increase in foreign profit repatriation due to US tax relief. Regardless of the country of the origin, the profit conversion will increase USD demand and cause appraisal pressures.
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