Last night, t’was Australia that showed
Employment growth had not yet slowed
And so, please expect
The central bank sect
To keep on the rate hiking road

They’ll not be content til they’ve slain
Inflation, and end this campaign
Yet, if all along
Their thesis is wrong
They’ll ne’er feel the citizen’s pain

On a very slow day in the markets, the most noteworthy news came from Down Under, where the Unemployment Rate fell back to 3.5% in a bit of a surprise while job growth continued at a speedier pace than analysts forecasted.  The market response was immediate with the Aussie dollar jumping sharply and it is now higher by 1.0% on the session, the leading gainer across all currencies, G10 or EMG today.  The rationale for the move is quite straightforward as market participants simply expect the RBA to maintain tighter policy than previously expected.  In the OIS market, the probability of a rate hike at the next RBA meeting on August 1st rose to 48% from just 27% prior to the release.  And correspondingly, Australian government bond yields jumped more than 8bps on the news.

Ultimately, the question that must be addressed is, does strong employment growth lead to higher prices overall?  As my good friend @inflation_guy has said consistently, we should all be ecstatic to have a wage-price spiral as the implication is prices rise AFTER our wages rise, so we are always ahead of the curve.  But we all know, and it has been made abundantly clear in this cycle, that wages follow prices higher.  One need only look at how prices continue to rise on a much more continuous basis than your salaries to see this clearly.  

However, this is gospel in the central banking sect of economists, that tight labor markets drive the general price level higher.  You may have heard of the Phillips Curve, which was a study done in 1958 regarding the relationship between the price of labor (i.e. wages) and the unemployment rate in the UK from 1861-1957.  William Phillips was the New Zealand economist who performed the analysis and basically it confirmed what we all learned in Economics 101, reduced supply of labor drove up wages while an increased supply of labor pushed wages lower.  Nowhere in the study did it discuss the general price level.  That came later with a litany of big name economists, finally with Milton Friedman explaining that in the long-run, there was no relation between wages and inflation, although on a short-term basis, it could evolve.

As so often happens in today’s world, it was easier to take the short-cut view, and that had an intuitive appeal, hence the current central bank mantra of we must bring wage growth down.  (Will they ever get concerned over bringing money growth down?  I fear not.).  At any rate, this is the widely accepted view of the world and so whatever its structural merits, when employment data shows a tighter labor market, the market response is to expect higher policy interest rates.  This was the story last night, hence the Aussie’s rally along with yields Down Under, and this has been the story consistently since the beginning of 2022, when global central banks embarked on the current round of policy tightening.  This is also why we consistently hear Chairman Powell explain that in order for the Fed to reach its 2% inflation target, there will need to be some pain, i.e. people need to lose their jobs.

But away from that, there has been very little of note ongoing.  Equity markets in Asia were unable to match yesterday’s modest gains in the US, with the Nikkei (-1.25%) the laggard of the bunch.  European bourses, however, have had a better go of it, with most of them higher on the order of 0.4% although Sweden’s OMX is down nearly -1.0% on the session bucking the trend.  US futures this morning are softer as there were several weaker than expected earnings numbers overnight including Netflix and Tesla.

In the bond market, Treasury yields have moved higher by 3bps this morning in the 10-year space, but even more in the 2-year space as the yield curve inversion gets deeper, now back above -101bps.  However, European sovereign bonds are little changed on the day with no data of note and the market trying to determine just how hawkish/dovish the ECB will be one week from today.  As to JGBs, their yields have stopped rising and they remain 5bps below the cap.  Do not expect any BOJ action next week.

Oil prices are a touch higher after a lackluster session yesterday, but remain above the key $75/bbl level.  Meanwhile, gold (+0.25%) continues to edge higher and is once again closing in on $2000/oz despite obvious catalysts or lower US interest rates.  As to the base metals, both copper and aluminum are nicely higher this morning as the entire commodity comlex is feeling some love.

Finally, the dollar is under pressure as not only is AUD firmer, but also NOK (+1.1%) on the back of oil’s gains, and virtually the entire bloc except for the pound (-0.3%) which still seems to be suffering from yesterday’s inflation data.  In the EMG bloc, CNY (+0.8%) is the leading gainer, a surprising outcome given its generally managed low volatility, but the fact that the PBOC did NOT reduce the Loan Prime Rate last night, in either the 1-year of 5-year term, was a bit of a surprise to the market as there is a growing belief the Chinese government will be adding more stimulus to a clearly slowing economy there.    But in this bloc, there are also a number of laggards with MXN (-0.4%) the worst of the bunch on what appears to be some profit-taking as traders start to position for the first rate cut since October 2020.

On the data front, yesterday’s housing data in the US was soft, with downward revisions to the previous month’s numbers.  This morning we see Initial (exp 240K) and Continuing (1722K) Claims as well as Philly Fed (-10.0), Existing Home Sales (4.20M) and Leading Indicators (-0.6%), the last of which have been pointing to recession for nearly a year.  However, once again, I expect the dollar will be beholden to the equity markets as none of these data points are likely to move the needle ahead of the FOMC next week.

For now, I think choppy price action is the likely outcome until we get more clarity from Powell and the Fed, as well as Lagarde and the ECB next week.  Who will be the most hawkish?  That is the $64 billion question.

Good luck
Adf