by James Picerno, The Capital Spectator
Yesterdayâs upbeat report on consumer spending and income in the US provides fresh support for last weekâs moderately hawkish comments from Fed officials, who hinted that another interest-rate hike is near, perhaps as early as next monthâs Federal Open Market Committee (FOMC) meeting. Yet support for pricing in a new round of policy tightening is modest at best via Treasury yields. Is that because job growth is expected to slow in this Fridayâs employment report for July after two months of strong increases?
Total nonfarm payrolls are on track to rise by a moderate 175,000 in August, according to Econoday.comâs consensus forecast. Thatâs a decent gain, but itâs well below Julyâs increase of 255,000 and Julyâs 292,000 surge. Monthly data is noisy and so itâs best to focus on the year-over-year trend. The August estimate translates into a 1.74% increase vs. the year-earlier level, fractionally above Julyâs annual pace.
Job growth has clearly slowed in year-over-year terms, which isnât terribly surprising for an economic recovery thatâs celebrated its seventh birthday in Juneâone of the longest expansions on record, according to NBER data. The question is whether the Fed will feel compelled to continue squeezing rates when the trend for job growth is on a downward trajectory?
The Treasury market isnât discounting the possibility of a rate hike in the near term, but thereâs still a fair amount of skepticism. Consider the 2-year yield, which is highly sensitive to rate expectations. Although this widely followed maturity has bounced higher in recent weeks, yesterdayâs rate eased to 0.81%, based on daily data from Treasury.gov. Thatâs still well below the nearly 1.0% rate that prevailed in early March, when fears were widespread that a new recession was lurking.
Fed fund futures yesterday (Aug. 29) were pricing in a 21% probability of a rate hike for the Sep. 20-21 FOMC meeting, down slightly from last weekâs peak, based on CME data.
Is the crowd is underestimating the prospects for a rate hike? âAt some point, if the Fed thinks the market misunderstands, thereâs a very clear way that they can realign those expectations, and thatâs by saying, look our economy is in very fine shape,â Carl Tannenbaum, chief economist at Northern Trust, tells CNBC. âItâs different from others, so we donât have to do what other central banks are going to do, and in order to avoid financial excess down the road, weâre going to remove just a little bit of excessive monetary accommodation.â
Fridayâs employment report will no doubt be a key factor for moving market sentiment, one way or the other. Meantime, Treasury yields leave room for doubt about the timing of the next rate hike, in part because inflationary pressure remain muted. Despite relatively firm growth in consumer spending, the core personal consumption expenditures (PCE) price index, which excludes the volatile food and energy components, rose just 1.6% for the year through Julyâcomfortably below the Fedâs 2% target.
The consumer spending report for July âis a mixed bag for the Fed,â says Michelle Girard, chief economist at RBS via Reuters. âWhile the consumer sector is continuing to advance solidly, progress towards the Fedâs inflation mandate has stalled. It strengthens the case for an increase in interest rates, but does not suggest an urgency for policymakers to act in September.â
The Treasury marketâs implied inflation forecast doesnât disagree. Indeed, the widely followed yield spread for the 5-year nominal Treasury less its inflation-indexed counterpart has been trending lower for months (black line in chart below).
Downward momentum still has a head of steam for the benchmark 10-year yield as well, based on a set of exponential moving averages (EMAs).
EMAs for the 2-year yield, on the other hand, appear to be close to reversing, which would signal higher odds for higher rates in the months ahead.
Much depends on how this Fridayâs update on August payrolls compare. But as Bloomberg advises, âAugust nonfarm payrolls have fallen short of estimates in each of the past five years.â
Perhaps the Treasuryâs marketâs skeptical outlook the prospects for a rate hike is warranted after all.