Subdued markets await Friday’s key jobs data

US equities saw a mixed session yesterday, perhaps given mixed messages from the economic data. The S&P 500 index slipped 0.5% back from recent highs, but still managed to close above the 4400 level. Meanwhile, the Nasdaq 100 posted a 0.1% gain and the Dow a 0.9% loss. Yesterday’s ADP’s estimate of the number of jobs added to the US economy in the month of July showed just 330K jobs being added, less than half of analyst expectations for a 695K reading. The latest survey from Reuters as a result has seen economists lower slightly their estimates for Friday’s key NFP number to 750K (it was above 900K at the start of the week). This weighed on the US dollar at the time, but economists were quick to remind market participants that ADP has had a poor track record in predicting NFP in recent months, and ADP just covers private sector employment, therefore missing out on the expect 130K in government job gains in the month of July (mostly linked to education). Moreover, the ISM Services PMI survey, which was released a few hours later, showed employment growth accelerating in July; the employment subindex rose to 53.8 from 49.3 in June, a month when 850K jobs were added to the US economy. Meanwhile, the headline ISM Services index number rose to a record high in July of 64.1, boosting confidence in the strength of the US economy at the start of Q3; earlier in the week, ISM Manufacturing PMI had fallen more than expected, implying a faster than expected slowdown in activity in the sector. But a strong Services survey will boost confidence that the slowdown in manufacturing is more as a result of US consumers switching consumption to services as pandemic restrictions are lifted/vaccination rates rise, rather than being indicative of a broader deceleration in US growth conditions.

Ahead of the Thursday open, US equities continue to broadly trade within recent ranges, with E-mini S&P 500 futures currently trading a touch higher but still close to 4400 and other major US indices also subdued. Equity market participants will likely continue to refrain from making any big new bets ahead of Friday’s all important US jobs report for the month of July. For now, equity investors are now reacting much to rhetoric from FOMC member, which seems to be drifting in a more hawkish direction. Vice Chairman of the Fed Richard Clarida spoke on policy yesterday and said that the US economy is on track to meet the Fed’s employment and inflation goals by the end of next year, consistent with the commencement of a hiking cycle in 2023. This is the most specific guidance offered from a senior Fed member on when the interest rate hike cycle will begin yet. Moreover, he said that if his baseline expectation for healthy job gains over the next few months does come to fruition, he could imagine himself supporting an announcement to reduce the pace of QE purchases at some point later in the year. His commentary on the Fed’s tapering timeline were thus less specific than that offered in recent days from other Fed officials; to recap, Fed’s Waller earlier this week called for a taper announcement to commence in October should the next two job reports be strong, but more influential Fed member Braindard said she would prefer to wait until October before making any judgement on whether the US is ready to taper. A few other Fed speakers were also on the wires last night; Fed’s Kaplan, who is typically more hawkish, said that reducing the monthly asset purchases “soon” would allow for a more “patient approach” to hiking interest rates. Fed’s Bullard, meanwhile, offered a similar message, arguing that tapering sooner could “clear the way” for rate hikes in 2022, if they are needed, i.e. if inflation remains persistently higher than expected, as some Fed officials fear – note that Clarida also said yesterday that the risks to his inflation forecast (i.e. for the current spike in US inflation to be transitory) lay to the upside.

Similarly to equity markets, US bond markets did not show much of a response to yesterday’s US data or arguably more hawkish Fed speak. 10-year yields have hardly moved at all on the week so far and continue to consolidate just below 1.20%. 10-year TIPS yields continue to consolidate just above record lows around -1.20%. Conversely, FX markets did see some choppiness. The US Dollar Index (DXY) yesterday pushed above the week’s prior 91.80-92.20 range, though ran out of steam in the 92.30s and has since dropped back to 92.20. Dollar bulls likely want to see expectations for a strong jobs gain on Friday confirmed before piling in to push the dollar higher. Most of G10 FX markets are subdued this morning amid a lack of catalysts; EURUSD is flat just under 1.1850, USDJPY is flat close to 109.50, AUD, NZD and CAD are each a modest 0.2% higher. Meanwhile, GBP saw very little reaction to the latest BoE policy decision; the bank voted to leave interest rates unchanged at 0.1% and its total QE envelope unchanged at £895B as expected, with only one of the potential two touted hawkish members dissenting on QE. The bank released fresh economic forecasts, which saw a modest downward revision to its 2021 GDP growth forecast to 7.7% from 8.0%, though the 2022 forecast was upgraded to 4.0% from 3.3%. Inflation forecasts saw a heft lift, with the bank now seeing inflation averaging 2.7% this year (up from 1.9%) and 3.3% in 2022 (up from 2.2%). Unemployment forecasts saw sizeable downwards revisions and is seen ending 2021 at 4.7% and 2022 at 4.5%. The bank “some modest tightening of monetary policy over the forecast period is likely to be necessary to be consistent with meeting the inflation target sustainably in the medium term”, and so net, was a modestly hawkish affair – it seems as though the BoE and Fed will be lifting interest rates according to similar timelines.

Finally, taking a quick look at crude oil prices; it was another ugly day in crude oil markets yesterday, with WTI prices dropping a further $2.0 from above $70.00 to current levels only just above $68.00. Prices were hit yesterday by a surprise build in US crude oil inventories of 3.6M barrels yesterday. However, in a positive sign for US fuel demand, gasoline stocks saw a larger than expected 5.3M barrel drop. More importantly for crude oil prices right now is the fact that market participants remain concerned about the impact on oil demand from the worsening the global pandemic, which is being driven predominantly by the spread of the delta variant that first emerged in India. According to a Reuters tally, global Covid-19 cases surpassed 200 million on Wednesday, with cases now rising in 83 out of 240 countries worldwide. Whilst cases are rising in the US, the country’s high vaccination rate is instilling confidence that the strict restrictions on daily life seen in 2020 and early 2021 will not be reimposed. Countries with lower vaccination rates are more vulnerable to a return to lockdown, however.

Perhaps most importantly for crude oil is growing concern that the world’s second largest economy (and crude oil consumer), China (whose vaccination rate is just 15% at the moment), may be headed back to the strict nationwide lockdowns of early 2020. The country reported the most locally transmitted Covid-19 cases (71) since January and, as of Wednesday, the country now has 144 areas deemed to be high or medium-risk, the most since the peak of the epidemic in the spring of 2020. The cities of Nanjing and Yangzhou, where the majority of recent delta variant infections have been reported, have implemented tight restrictions on inbound and outbound travel. Other cities have also had to lockdown various neighbourhoods amid infections cropping up and most cities, including the city of Wuhan, where the virus first emerged, are implementing mass testing programmes.

Given the tightening restrictions on mobility and economic activity in the country, analysts have begun to revisit their forecasts for economic growth in China this year; Nomura downgraded its Q3 forecast, as well as its full year 2021 forecast, explaining that “the draconian measures taken by the government are resulting in potentially the most stringent travel bans and lockdowns in China since the spring of 2020”. A return to severe nationwide restrictions in the world’s second largest economy would deliver a huge blow to global economic growth hopes. Meanwhile, across the East China Sea and in the world’s third largest economy, Japan (where the vaccination rate is around 30%), Covid-19 related restrictions are also being tightened as new infections in the country continue to rise (new infections hit a record above 5K yesterday). Japan decided today to expand curbs to cover more than 50% of its population, though many of the new curbs are voluntary. Reportedly there is a feeling amongst a panel of experts who advise the government on its Covid-19 response that the situation in Japan is now severe enough to declare a nationwide state of emergency, which would require stricter, mandatory restrictions (currently full state of emergencies are only declared in six prefectures, including Tokyo).

The Day Ahead

Eyes will be on the latest US weekly jobless claims report and US and Canadian trade numbers (both for the month of June), all of which is set for release at 1330BST. Fed’s Waller, who sounded hawkish on QE tapering earlier in the week, is scheduled to speak at 1500BST. Market conditions are likely to remain subdued today as traders await tomorrow’s key US jobs numbers.