US nonfarm payrolls stronger than expected. Initial hawkish market reaction quickly faded. NZ rates sharply lower on Friday as market starts to question RBNZ's 5.5% terminal rate projection

Friday saw a very strong nonfarm payrolls report, including much higher-than-expected average hourly earnings growth.  The initial market to payrolls saw higher US rates, lower equities, and a stronger USD.  But these moves quickly reversed, with the market sensing the Fed is still approaching the end of the tightening cycle.  The NZD continued to power higher, ending the week above the 0.64 mark for the first time in over three months while the NZD/AUD cross hit 0.94 for the first time since January.  NZ rates were sharply lower on Friday, with the market starting to question whether the RBNZ will need to take the OCR to a 5.50% peak after all.  In news over the weekend, several major Chinese cities announced further loosening of Covid restrictions which could see risk assets start the week positively.

The nonfarm payrolls report for November produced another upside surprise, with healthy job growth of 263k on the month (200k expected), led by the leisure and hospitality sectors.  Job growth continues to moderate – no surprise given the labour market is as tight as it – with the average payrolls gain over the past three months (272k) now close to its post-Covid lows.  But job growth is still running ahead of where the Fed would like it to be, with Powell earlier in the week saying anything above around 100k monthly jobs growth would tend to put downward pressure on the unemployment rate.  As it happened, the unemployment rate was unchanged, at an ultra-low 3.7%, due to a dip in the participation rate.

The real surprise from the payrolls report was the average hourly earnings data.  Wage growth jumped 0.6% in November, much higher than the 0.3% consensus, with the annual rate pushing back to 5.1%.  Prior to this report, average hourly earnings growth had appeared to be on a declining trend, but revisions to prior months have reshaped that picture.  Now, the trend in average hourly earnings growth looks to be running at around 5% annualised, a rate well above what would be consistent with the Fed sustainably meeting its 2% inflation target.

The initial market take was this had hawkish implications for Fed policy.  Market expectations for the peak in the Fed cash rate briefly pushed up to almost 5%, before easing back to just above 4.90%.  The Fed is still expected to raise rates by 50bps later this month, which would take the upper end of the target range for the cash rate to 4.50%.

Interestingly, the hawkish market reaction to the data didn’t last long.  The US 2-year Treasury rate jumped by more than 20bps after the data was released but closed only 4bps higher on the day.  The US 10-year rate ended slightly lower on the day, closing below 3.50% for the first time since September.  After briefly steepening after Powell’s speech earlier in the week, which was seen as less hawkish than feared, the 2y10y yield curve is back near post-Volcker lows of almost -80bps, pointing to a deep recession in the US next year.

Equity markets gapped lower after the data, before retracing over the remainder of the session as Fed rate hike expectations moderated.  The S&P500, which was down as much as 1.2% at one stage, ended the day only 0.1% lower.  It was the same story in currency markets, the BBDXY USD index jumping almost 1% in the immediate aftermath of the payrolls release before subsequently giving back most of that move and ending the day broadly unchanged.

It’s not immediately obvious why there was such a strong market rejection to the much higher-than-expected wage data.  It’s possible the market senses the upcoming economic downturn ahead – leading indicators are pointing to recession and the ISM Manufacturing Index has fallen into contractionary territory for the first time this cycle – and sees the labour market as a lagging indicator that will ultimately roll over in time.  Powell’s speech from earlier in the week was also less hawkish than it might have been, which perhaps has given investors some confidence that the Fed cycle is indeed approaching an end.  It could also be related to market positioning, with investors possibly unwinding popular consensus positions (short bonds, long the USD, underweight equities) ahead of year end.

Alongside the JPY, the NZD was the standout performer in the FX market on Friday, continuing its recent stellar run.  The NZD was up 0.6%, pushing above the 0.64 mark for the first time since August, taking its gain on the week to a chunky 2.6%.  Friday’s appreciation in the NZD was even more notable given other commodity currencies were generally weaker, the CAD and AUD down 0.3% and the NOK off 0.5%.  The NZD/AUD cross closed the week above 0.94 for the first time since January, consistent with market expectations for the RBA to stopping hiking at a much lower terminal rate than the RBNZ.

Of the majors, EUR recovered from its initial post-payrolls dip to close the week at 1.0535, its highest level since early July.  JPY was the top performing currency on Friday and the week (+3.5%), with the pullback in US Treasury rates narrowing the US-Japan interest rate differential and taking some of the immediate pressure off the BoJ’s Yield Curve Control policy.  USD/JPY was down 0.8% on Friday, ending the week below the 135 mark for the first time since August.

In China, several cities announced a further relaxation of Covid restrictions over the weekend, which may see risk assets (and the NZD and AUD) start the week on the front foot.  Following Beijing’s move on Friday to allow low-risk people to self-isolate at home, over the weekend Shanghai, Shenzhen, and Zhengzhou (home to Apple’s huge iPhone factory) removed Covid testing requirements to use public transport. State media also appear to have softened their tone on the risks of Covid, referring to the less deadly nature of Omicron, consistent with a shift towards eventually opening up and living with the virus next year.  The easing of restrictions could lead to a surge in daily cases in the coming few months, hitting near-term economic activity, but the medium-term outlook would be much brighter without the zero-Covid policy.

Canada’s employment report on Friday was also stronger on balance, with 10k job growth matching consensus expectations but the unemployment rate unexpectedly falling to 5.1%, near its lowest levels since the 1970s. The market still favours the Bank of Canada to hike by 25bps next week, with a 50bps move seen as an outside chance (~25% priced in).

NZ rates fell sharply on Friday, following the lead of the US and Australian bond markets.  The 2-year swap rate was down a chunky 9bps, taking it back to 5%, while 5 and 10-year rates were 11bps lower.  Market expectations for the peak in the OCR have fallen back to around 5.30%.  The market has started to question the RBNZ’s 5.50% terminal rate projection over the past week given the downturn in pricing and employment intentions from the ANZ Business Survey and further indicators that global growth is likely to decelerate sharply over the next year.  Additionally, the NZ TWI is now some 5% higher than the RBNZ’s November MPS assumption, which should be a disinflationary tailwind next year, if sustained at these sorts of levels.

EU governments finally agreed to a price cap for Russian oil imports of $60, lower than the originally tabled $65 due to pushback from several countries including Poland, but higher than where Russia currently sells its oil (suggesting there shouldn’t be much impact on the market).  Separately, the EU’s embargo of seaborne Russian oil also comes into effect today. On the supply side, OPEC+ kept oil production unchanged at its meeting overnight, as expected.  Oil prices were down slightly on Friday, at around $85.50 on Brent crude, and are trading near year-to-date lows.

The main highlight in the session ahead is the US ISM Services Index.  The index is expected to fall to 53.4, which would be a post-Covid low, but unlike its manufacturing counterpart, it is expected to remain comfortably in expansionary territory.  It’s a quieter week ahead in terms of economic data and central bank decisions (next week is much busier).  The other key event is the RBA rate decision tomorrow where the strong consensus is for another 25bps hike, which would take the cash rate to 3.10% (markets are around 80% priced for such an outcome).  Domestically, there are some partial indicators of Q3 GDP released while RBNZ Chief Economist Conway will be speaking about the November MPS on Friday morning.