US – Tight labour market remains a headache for the Fed
Last week showed continued signs of hot labour markets in the US: December’s employment report showed strong job growth in the US, with NFP adding 223,000 jobs and the unemployment rate falling to 3.5%. The ADP employment report showed 235k additions (versus a 150k survey) and the ratio of job openings/unemployed remained at stubbornly high of 1.74x. On the positive side however, wage growth continued to slow in recent months, with hourly wages rising by 0.3% MoM and the 12-month increase declining to 4.6%, while the participation rate increased to 62.3%. ISM prices paid also declined in both services and manufacturing.
The ISM services index dropped by more than expected to 49.6 in December from 56.5 in November demonstrating that the service sector contracted for the first time in six months. The details of the report showed significant declines in business activity and new orders. Following the drop, duration rallied strongly into Friday’s close, with US 2Y Treasuries rallying ~ 20bps.
Markets remain undecided on whether the Fed will hike 25bp or 50bp at the February meeting and are currently pricing approximately a 65% chance of a 50bp hike. The key focus this week will be Thursday’s CPI print, for which markets are pricing a YoY headline change of 6.4%.
Eurozone – Headline inflation drops but core is rising is a problem
Inflation in the eurozone fell by more than expected in December, ending a two-month period when the rate was in double digits. The flash index rose at an annual rate of 9.2%, down from 10.1% in November and a record annual rate of 10.6% in October. The drop exceeded expectations of a fall to 9.5% in a Bloomberg survey of economists and government debt rallied from Tuesday when it became apparent that Germany’s release had undershot. Even so, core inflation rose to a new high of 5.2% from 5.0% in November. This remains a big problem for the ECB, as it will stay on course with its hawkish rhetoric and is therefore likely to decouple from the Fed more meaningfully over the next few months. We think the ECB is likely to continue raising rates, with markets pricing hikes of 49bp and 44bp for the next two meetings and a terminal rate of 3.4% overall.
China Reopening – Next signs of progress
Last week, the Chinese government signalled further willingness to open the economy. Firstly, China is considering easing its “three red lines” policy, which imposed strict debt and cash-flow targets on real estate firms and contributed to the avalanche of defaults and halts to construction projects. The policy may be relaxed by allowing some property firms to increase leverage and extending the grace period for meeting debt targets. Secondly, the government will consider resuming Australian coal imports, after a ban of more than two-years, as relations between the two countries improve; four major importers may be allowed to make new purchases as soon as April. Lastly, China is loosening its border controls to encourage international travel.
Our model that tracks mobility points to an already improving situation on the ground, with current activity levels at around 60% of January 2020. That said, we note that there is a differential in terms of the progress of the recovery with Beijing leading as Shanghai lags. As the recovery continues, we believe cyclical assets including energy and commodity-linked currencies have room to outperform, but we also note that this may drive global energy-inflation back up.
Algebris Investments’ Global Credit Team
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