Economic releases over the past 24 hours have forced short-term interest rate traders to price in higher odds that the Federal Reserve delivers on its June forward guidance and hikes rates twice more this year to a terminal level of 5.5-5.75%.
Currently, pricing for November’s meeting implies a 50% probability of a second hike, with a terminal rate of 5.44%. This has led the 2-year Treasury yield to trade back above 5% for the first time since the collapse of Silicon Valley Bank in March, a dynamic that we expect to continue providing a floor under the dollar. Driving the more hawkish expectations have been signs that some FOMC members wished to raise rates back at June’s meeting instead of pausing to await further economic information, a strong signal from the ADP measure of private employment that tomorrow’s payrolls report may beat expectations, and another robust services PMI for June. This has all taken place ahead of tomorrow’s Nonfarm payrolls report, the last official jobs release before the Fed’s July 26th meeting.
The market implied terminal rate for the Fed has risen to its highest level since the March banking crisis, with a further 1.5 rate hikes now priced by November
Fed members express preference to hike in June
Despite Chair Powell’s comments at the June press conference that the decision to pause the hiking cycle in order to observe further information was unanimous, the published meeting minutes suggest there was in fact dissent amongst policymakers with some favouring another 25bp hike. Behind their preference to hike rates were signs that the labour market remains tight and the economy resilient, posing the threat of inflation persistence.
While the mixed nature of the payrolls data prior to June led the consensus to become more cautious on placing too much weight on the labour market data at the risk of overtightening policy, subsequent releases suggest that the labour market remains tight and the consumer is still in a healthy position.
ADP employment doubles expectations, raising odds of a strong payrolls report
The ADP measure of private sector employment showed 497k jobs were added in the past month, above the 272k above consensus expectations but consistent with other indicators in June. On a sectoral basis, employment in services rose 373k, led by a 232k increase in leisure and hospitality, while the ailing manufacturing sector still posted employment growth of 124k, although a large portion of the jobs created were in construction (+97k). While we’d caution against overinterpreting the ADP numbers, given they are historically a poor measure of the official payrolls data released tomorrow especially following the methodological revamp last summer, the significant upshift in the measure’s pace of hiring is noteworthy.
As such, markets have positioned for the increased likelihood that the net employment figure within the establishment survey exceeds the 225k consensus, leaving a rate hike at July’s meeting a near-certainty.
ISM services PMI confirms signs of consumer resiliency and consistent employment growth
The ISM measure of services activity printed at 53.9, above expectations of 51.2 and up from May’s reading of 50.3. On a surface level, the data suggests that the consumption backdrop improved towards the end of Q2, not only following lacklustre PMIs but also data showing low real levels of personal spending in May. In combination with the ADP measure of employment, the ISM employment sub-index also points towards an increase in services employment following a stagnation in May.
This can also be viewed as a sign that the consumer backdrop is expected to remain robust by firms.
While the Fed will find some relief in the fact that the prices paid index fell from 56.2 to 54.1, the lowest reading since March 2020, the reduction in cost-push inflation within the sector isn’t necessarily indicative that the level of price growth faced by the consumer has necessarily fallen. Overall, and in combination with the ADP measure, the ISM services PMI underscores the exact concerns that some FOMC members have over the resilience of the economy and threat that poses in getting inflation back to the 2% target.
The DXY index climbs back to the top of its recent range on the back of rising Treasury yields
Simon Harvey, Head of FX Analysis