The Outlook for Rate Cuts

Equities remain skittish this morning following Friday’s relatively solid jobs reports which seemingly muddies the outlook for potential rate cuts near-term. While some media outlets argue the stronger-than-expected rise simply mitigates the need for a 50bps hike next month instead of a quarter point cut, others recognize the Fed now has reason to potentially delay policy action altogether until later in the year.

U.S. equities are down 0.23%, currently trading at 2,983.75 as of 9:00am ET.

On Friday nonfarm payrolls rose 224k in June, significantly more than the 160k gain expected, according to Bloomberg, and a five-month high. May payrolls were revised down from 75k to 72k and April payrolls were revised lower from 224k to 216k. Thus, the overall change in nonfarm payrolls (June data + net revisions) was 213k. Furthermore, the three-month average rose from 147k to 171k, while the six-month average was little changed at 172k. 

Household employment rose by 247k in June, following a 113k rise the month prior. The labor force, furthermore, rose by 335k in June, following a 176k gain the month prior. Thus, the unemployment rate ticked up one-tenth of a percentage point to 3.7% in June, and the participation rate also rose a tenth of a percentage point to 62.9%, a three-month high.

Average hourly earnings rose 0.2% in June, a tenth of a percentage point less than expected, according to Bloomberg, and following a 0.3% gain in May. Year-over-year, wages rose 3.1% in June for the second consecutive month, down from the near-term peak of 3.4% reported in February.

Finally, the work week remained at 34.4 hours in June for the third consecutive month.

Bottom Line: A stronger-than-expected June payroll report tempers concerns that last month’s disappointing report was the beginning of a new, weaker trend in job creation and furthermore, alleviates mounting pressure on the Fed to act sooner than later. While the Committee remains open and willing to provide additional accommodation as needed, the Fed will continue to watch the data and “react.” In other words, if the data up until this point was not enough to convince policy officials that a reduction in rates was appropriate, a solid June employment report will hardly be the data point to put them over the edge.

That being said, there remains ample reason for concern, particularly as wage growth continues to slow, manufacturing activity wanes, consumer spending remains uneven and the housing market is displaying clear signs of weakness. So, a further deterioration in the data over the next three weeks could change the Fed’s opinion rapidly, especially as a growing number of officials have already indicated skepticism of the underlying strength of the economy independent of one above +200k NFP report. Nevertheless, according to the June dot plot, the majority of officials still see rates unchanged through the end of the year, a staunch differential to market expectations pricing in a July rate reduction with near 100% certainty. Thus, the market could be poised for a severe disappointment if the Committee’s assessment of current conditions and the need for the cycle’s first rate cut aren’t more aligned come the July 31st FOMC meeting.

In international news, in snap elections over the weekend, Greece's opposition conservatives returned to power with a landslide victory, unseating the incumbent leftist Syriza party. According to reports, the New Democracy leader Kyriakos Mitsotakis has pledged to cut tax rates on businesses from 29% to 20% in two years and lower taxes on individual incomes, while slashing property taxes. He's also promised a major round of deregulation, with a focus on investment and growth.

In other international news, Turkish President Erdogan dismissed the central bank Governor Murat Cetinkaya, whose four-year term was due to run until 2020, replacing him with his deputy Murat Uysal. Erdogan’s latest move has reignited concerns about independence, fueling concerns borrowing costs will be lowered faster than expected ahead of the central bank’s policy decision on July 25th. 

The lira declined as much as 3% against the dollar overnight according to Bloomberg.

Today consumer credit is expected to rise by $17.000b in June following a $17.497b rise in May.

Later this week, on Tuesday, the NFIB Small business Optimism Index is expected to decline from 105.0 to a reading of 103.3 in June and job openings according to JOLTS – the Job Openings and Labor Turnover Survey – are expected to rise from 7.449m to 7.465m in May. On Thursday, the CPI is expected to be flat in June and rise 1.6% over the past 12 months, a four-month low. On Friday, the PPI is expected to rise 0.1% in June and 1.6% year-over-year, the weakest pace since November 2016.

At 10:10am ET, St. Louis Fed President James Bullard will make welcoming comments at the Official Monetary and Financial Institution Forum Conference at Washington University in St. Louis, and at 2:00pm ET, Atlanta Fed President Raphael Bostic will speak at the same conference at Washington University. Also at 2:00pm ET, Fed Vice Chairman Randal Quarles will give a speech at a Boston Fed-hosted conference on stress testing.

Later this week, on Wednesday and Thursday, Fed Chairman Jerome Powell will deliver his semi-annual Monetary Policy Report to Congress. Market participants will be listening closely for any clues to the Fed’s intended pathway for policy at the upcoming July 31st FOMC meeting. 

-Lindsey Piegza, Ph.D., Chief Economist