Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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NFP Preview: Disappointment ahead ?
Christopher Dembik
Head of Macroeconomic Research
Summary: Most market participants expect tomorrow's nonfarm payroll employment report for December will confirm a slowdown in the U.S. job market on the back of the re-introduction of partial lockdowns and an increased number of Covid cases, with consensus standing at +100K versus +245K in November. Given the disappointing December's ADP report (at -123K) and available data about real-time activity and business surveys, we think the consensus is still too rosy. We believe that the risk of a negative reading - which would be the first time since last Spring if confirmed - is higher than most think and has not been priced in in the market yet. A negative reading would certainly be transitory, but it would paint a disappointing picture of the U.S. economy and signal that many challenges remain to escape from the pandemic.
Tomorrow’s nonfarm payroll employment report for December may come as a bad surprise for most market participants. The consensus expects that job creation will drop to 100K from 245K in November, with the unemployment rate (U-3) remaining unchanged at 6.7%. Judging by the available data, the consensus might be a bit too rosy. Aligned with the December’s ADP report (out at -123K), the nonfarm payroll report may see a decline of jobs in total U.S. employment in December, which would be the first time since April if confirmed. Though it might be transitory, a negative print would be a shock to most investors that viewed the U.S. economy as fairly resilient in year-end.
There are two main reasons that could explain the deterioration in the U.S. labor market:
- Confronted with rising numbers of Covid cases, many States have re-introduced restrictions and partial lockdowns in December, with the tougher lockdown being implemented in California. It is likely to result in a large decline in job creation in the services sector, which has already been captured by the ADP report (negative print at -105K with the sectors most vulnerable being leisure & hospitality, and trade & transport). Real-time data confirms the impact of the pandemic on economic activity, then pushing employers to pull back on hiring in December. If we only look at visits to retail and recreation stores, one of the most affected sectors by the pandemic, activity has decreased by a stunning 28% in December compared with the baseline. The extent of the decline is more or less similar to that in March when the outbreak started.
- Another factor that could explain the sluggish dynamics in the labor market is the continued decline in state and local government employment. After providing intense support to the economy in the worst period of the pandemic, many state and local governments had no other choice but to shed labor to balance budgets. Since the beginning of the crisis, total government employment has decreased by 1,31 million with a decline of 585K over the past three months. However, with the new stimulus package worth $900bn expected to kick off in the coming weeks, we could see this trend stops or even reversed in January-February.
The labor market recovery in cyclical industries is still patchy. Employment growth in construction is standing at -2.3% YoY while in manufacturing it is also in contraction at -4.7%. Looking at the mining and logging sector, employment growth is in free fall, at -13.8% and does not show real signs of near term improvement.
In December, the ADP report was negative for the first time since April, shedding 123K jobs which represents a 211K miss versus +427K in November.
Retail and recreation activity declined in December again on the back of further restrictions implemented to fight against the pandemic. The drop reached -28% at the end of December compared with the baseline.
In terms of monetary policy, a soft jobs report will probably have little to no impact. The December’s FOMC minutes provided clear guidance that near-term adjustments to asset purchases are unlikely and that monetary policy will remain accommodative for the time being. All the participants agreed that the current monetary policy stance and path of asset purchases are appropriate and that any changes should not be driven by specific numerical criteria (such as a level of unemployment) but by a broad and qualitative assessment of the recovery.
On a final note, a negative print might increase volatility on the EURUSD cross and temporarily favor safe assets, but it should not affect the long term trend. With the cyclical recovery in sight, the search for value and diversification, we remains bullish on EURUSD in the near and medium term, with a first target at 1.25. We especially consider that continued optimism around the U.S. fiscal stimulus and the Biden administration, as well as relatively clean positioning suggest there is room for further upside in the near term.
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