Payroll call

Hello and welcome to Global Research Unlocked, the interest rates and FX series. This podcast is based on our weekly client conference call, where our strategists, along with guests from other parts of Bank of America Global Research, discuss the most topical and pressing questions faced by our market. I'm Sfia Salim, Co-Head of Global Rates Strategy.

Today is Friday, 5th of June, and our weekly global rates call will focus on the U.S. payroll report that was just released earlier today. For that, I'm pleased to be joined by Aditya Dutt, Head of U.S. Economics, Shruti Mishra, U.S.

Economist, Alex Cohen, G10 FX Strategist, Mark Havana, Co-Head of Global Rates Strategy, and Bruno Brazinha, Senior U.S. Rates Strategist. What a fantastic surprise today's payroll report has been.

Shruti, you were above consensus on NFP, but could you have imagined a number as high as today? Good morning, everyone. Yes, this is definitely a very strong jobs report.

As Sfia mentioned, huge beat on NFP. It is above all expectations and Bloomberg consensus, above our above consensus forecast as well. Private jobs at 120,000 were not too far off from our 100K forecast, which is also above consensus.

Everything very comfortably above our break-even estimate. We're now averaging on a five-month basis around 100,000 for private jobs and a three-month basis even higher at about 160,000. I think private jobs number at 120,000, and as we go into more details, we'll be able to see where it is coming from.

I think that is something we could have imagined, wasn't too far off from our forecast, but I think what was very surprising here, and the icing on the cake to the strong jobs report were the upward revisions. We got 90,000 in upward revisions to the last two months, which reaffirmed the strength in the March and April payrolls, and this is the first time we've gotten upward revisions since June last year, and this is the highest level of upward revisions since Jan last year. All in all, the headline number is showing a really strong jobs report.

Which sectors are really driving the surprise? Yes, so that's where it becomes more interesting. There are basically just two sectors that are driving the surprise, leisure and hospitality on the private side, which added 70,000 jobs out of 90,000 private sector services jobs that we got this month, and on the government side, you had local government non-educational jobs.

So, you know, think of things like infrastructure, some government security, et cetera. Those jobs came in at a pretty surprising 50,000. Now, when you combine both of these things, this looks like early World Cup hiring to us.

This is a risk that we had flagged in our preview. Our base case was that given the timing of the World Cup, World Cup hiring would start showing impact from the June jobs report, but we had flagged risks that you could get some early World Cup hiring in leisure and hospitality. This looks like pretty much all of the World Cup hiring happened earlier.

If you compare these sectors to their trend, these two sectors came in about 60 to 100,000 higher than their trend growth. So I'd say that's probably out of the jumbles that we got today, about 60 to 100,000 looks like the World Cup impact. This is definitely a good report, but some of this is, I think, important to remember.

This is World Cup hiring, but you will get payback for this in August. What about the household survey? Were there any positive signs from there too?

Yeah, the household survey was actually pretty good too. We got the household employment moving up by about 150,000 this month. This was the first increase in household employment this year.

There had been this conversation that household employment and establishment survey employment have been diverging. This helps a little bit on that front, but we'd still keep an eye on this. Household unemployment, which is also good, it was down by 66,000, with the unrounded U rate down from 4.337% to 4.296%.

The rounded U rate, as we know, remained at 4.3, which is also good, in line with the forecast. Alternative measures of unemployment, U2 and U6 were down. However, the long-term duration of unemployment was up again.

So again, that's something to keep in mind. But all in all, even the household survey, this is in line with what we've been saying, that for the Fed to stay and hold focus on its inflation mandate, the unemployment rate at around 4.3% is a very good sign. Thank you, Shruti.

Aditya, now market participants, want to believe the Fed has a dovish bias? Is there anything at all from this report that the doves at the FOMC can still lean on? Thanks, Sphere.

Good morning, everyone. That's a great question. So I think that this report undoubtedly moves the distribution of risks in the hawkish direction.

So let's start with that, right? But does it move the distribution so far that now hikes become the base case? I don't think so.

What the Fed would lean on here is the fact that labor slack doesn't seem to be decreasing. The Fed doesn't lean against strong job growth per se. It leans against job growth when that corresponds with tightening of the labor market, right?

In other words, it's the balance of supply and demand that matters to the Fed. And to assess that balance, you can look at the unemployment rate. The unemployment rate has basically been flat for a year, bounced around a bit, but there's no clear sign yet of the unemployment rate moving meaningfully down.

And I think that is the single most important indicator from the Fed's perspective, as long as that stays above their estimate of the neutral rate, they won't get too worried that the labor market is going to be another source of inflationary pressures, which I think is the key condition that tips them in the direction of hikes. The other thing that the Fed would point to is that wage inflation honestly is not showing signs of picking up. Month over month, we were fine, year over year, now 3.4%.

If anything, we've been gradually trending down on wages. So looking at those two indicators, I think what they would say is, we're not going to lean against job growth for the sake of itself. The labor market seems to have stabilized, but it's not showing signs of re-accelerating or heating up.

And in those conditions, we can continue to look through some of this oil shock, because there's also a risk that with a lag, particularly as fiscal stimulus fades, you could start to see activity slow down and then eventually that could weaken labor demand as well. Because let's not forget that the saving rate still remains very low. And that does pose downside risk to economic activity going forward, just because inflation is so high.

More broadly, what is your read on some of the shifts that occurred within the FOMC lately? And what would you say is the likelihood of a hike this year in that context? All right.

So going back to my earlier comment, absolutely there has been a hawkish shift on the FOMC that is completely appropriate given the flow of data and the distribution of risk, the probability of a hike has increased. I would say for this year, our base case is that they're on hold. And I think if they're going to take some action this year, probably pretty even risks of a hike or a cut, particularly after today.

So the base case is kind of a low conviction base case, right? What we've heard from the Fed of late is much more hawkish. Waller, who was probably the most articulate to dub last year, the one with the most credibility, he is now sounding like what I just said, right?

That you want to stay on hold, but there are risks in both directions. The hawks have been much more vocal. Some of them have refrained from calling for hikes, but others are calling for hikes, right?

Logan, Hammock. And I think you might see that in the June dark plot as well. You might see two, three folks penciling hikes into their forecast for this year.

So things have definitely gotten a lot more interesting, but we haven't yet heard from Walsh. And yes, he's only one voter on the committee, but he's the most important voter. And he will be able to some degree move the conversation in the direction that he likes.

Of course, if there's an overwhelming case for hikes, he probably won't be able to resist it. But I don't think we're there yet. So we're still comfortable with the Fed being on hold for the rest of this year.

And now just looking near term, we have CPI next week and the University of Michigan Inflation Expectations Survey as well. Do you think these two are critical here after the strong NFP report? CPI, yes.

You, Mish, no. CPI, I think what really matters again is the read through the BCE. So you're going to get some knee jerk reaction at 8.30 a.m. on Wednesday morning, and then folks will run those data through their BCE model.

And either that initial reaction will be affirmed or reversed by like 8.40 or 8.45 at the latest. We've had this between CPI and BCE over the last several months. We're looking for a relatively soft core CPI trend of 0.20 percent, so the low consensus on that.

But again, the only thing that matters is what the read through is to core BCE and what we've learned over the last several months is that that is not obvious at all. And then on Thursday, probably matters more than you, Mish, is the PPI report. And then we'll be able to fine tune our BCE estimates.

The reason I think you, Mish, doesn't matter is that the Fed has essentially looked through it. There was a huge increase in you, Mish, inflation expectations after the Liberation Day tariffs were announced. Obviously, the actual increase in inflation was a lot more tepid than that.

So I think the Fed would look through you, Mish, even if it showed another pickup in inflation expectations. What I would watch for more than you, Mish, is on Monday morning, you're getting the new Fed inflation expectation survey. The Fed has been putting more weight on that.

If that starts moving up, then I think things get a little more uncomfortable for the Fed. Thank you, Aditya. Now, Mark, turning to you in terms of market moves, so we saw now two-year yields are up by over 10 basis points even, and the curve flattened.

Is that consistent with what you would have expected on such a positive surprise? Yes, Svia, it is. In our payroll preview, we had written down a range of expected outcomes for rates based upon where the unemployment rate printed.

And obviously, the unemployment rate was stable, though on an unrounded basis, it did decline somewhat. So if you just assume that today's data is more consistent with one-tenth drop in the unemployment rate, the values that we saw today are very consistent with what we expected going in. For one-year Fed pricing, we said it would rise by 10 to 20 basis points.

One year ahead, Fed pricing is up about 12.5 basis points. For the two-year, we said 10 to 20 basis points higher, two years up by 10 right now. Five-year, we said 5 to 10, 10 years up, 6.

So fairly consistent with what we had penciled in for such a beat. We did condition it on the unemployment rate, but nevertheless, I would think of this as a big employment surprise, and the values are roughly in line with what we might have guessed we would see as a result. And so what is market pricing now telling us about the expectations on the Fed part?

Is that aligning well also with what you hear in your discussions with the clients? Yeah, I think it's really interesting, Svia. And this is one area where we disagree with the market, and we think that the market is going to have to adjust how it's thinking.

So what we see when we look at Fed pricing is this. We see a market that is very reluctant to believe that the Fed can hike in the near term and certainly will not be hiking prior to the U.S. midterm elections. You can see that very clearly by the fact that through the October FOMC meeting this year, we're only pricing about 14 or so basis points of rate hikes.

The meeting after, which is after the midterms in December, is pricing in almost 24 basis points. So you're seeing a 10 basis point increase in market pricing right after the midterms. And then you've got the first Fed hike that is priced in January, and then you have, let's say, 50-ish percent odds of a second Fed hike by the middle of next year.

So what the market, I think, is reflecting to us is that there's a very high bar for Warsh to hike, and there's almost no way or very low probability that Warsh can hike before the midterms. This is obviously a market that thinks that political resistance on the Fed to hike is very powerful, especially ahead of the U.S. election. Now, we think the market's going to be proved wrong, or we think that there is a decent shot that the market has to reassess that because of what we might guess we hear from Warsh at the June meeting.

I phrase it this way when I talk to clients. Do we think that we are going to hear more of the Kevin Warsh who sounded very concerned about inflation at his Senate banking testimony, or do we think we're going to hear a Kevin Warsh that is more consistent with remarks that he made when he was lobbying for the job on television or at conferences? Which Kevin Warsh is that going to be?

And will the real Kevin Warsh please stand up? He will stand up in two Wednesdays at the podium, we think. And when he does, we suspect he's going to sound more like the Senate testimony Kevin Warsh.

He's going to sound more aligned with the committee. And if that is right, then we think the market will have to reassess further the timing of potential Fed hikes and likely start to assign a higher probability for Fed hikes that could occur even earlier. Not saying that the Fed will absolutely deliver on this, but based upon the data flow that we see, it seems quite likely that that is how the distribution of market pricing will indeed evolve.

Thanks, Mike. And Alex, now turning to FX, one would have thought that this report would be extremely bullish for the dollar. Is that what we've seen?

Yeah. Thanks, Fia. So the dollar did, of course, rally on today's report.

The net moves are, if we're looking across the G10, roughly like a half to three quarters of a percent versus most currencies. So I would say that's broadly in line, if not like slightly more than what we would expect on a strong report. So it's a decent move.

I wouldn't say it's an outsized move, although as we speak, it is continuing to push higher. So maybe it's a bit bigger even than it was initially. But notably, just say, at least for now, I mean, we're just starting to see the dollar kind of break out or kind of perk up out of the really tight range that it's been over the last three weeks.

This has been in the context of not just today, but for some time now, we've seen a pretty notable break higher in things like economic surprise indices of the US versus the G10 and to a lesser but still notable extent, rate differentials. So the dollar has kind of been lagging those things, and we're now just starting to see it maybe start to catch up a little bit. The one exception here today in the dollar is higher versus the Canadian dollar.

But the Canadian dollar has also outperformed the other G10 currencies on a similarly hot Canadian jobs report. So that's kind of the one exception. But generally, yes, higher dollar is continuing to move in that direction, and it's just now breaking out of the range.

We'll see if that holds. Do you see anything that actually can restrain that dollar appreciation near term? I think there's a few things to note here.

And first on the report itself, I mean, I think we could even be looking at a stronger dollar here had we seen an unemployment rate that would have ticked down versus just holding flat and on expectation, as others on the call have already noted. I think that didn't happen, and that would have been something that I think could have really been even a bigger tailwind for the dollar. As FedHike expectations have ticked up, we're kind of just back to roughly where we were a few weeks ago.

So I think you have that factor, and as Mark talked about, the market is just still somewhat reluctant to take that higher. We think that ultimately could be proven incorrect, but really, that's the Warsh factor. So they don't have to rehash all those arguments.

But just with a market that still sees a bar for hike as higher than maybe the fundamentals would suggest, that's also been a sort of nagging headwind for the dollar recently. And then finally, I would just note the other big obvious elephant in the room is just the Iran war. Here we've just been kind of living through a market that's been somewhat beholden to headline risk.

So there's a bit of kind of paralysis there that the market kind of was reluctant to really go any of the direction on this expectation that some deal or some version of reopening of the straight or moose is coming. And that's kept the lid on oil and also sort of kept a bit of a lid on the dollar just in terms of expecting that event to kind of play out at some point. Thank you for joining us today.

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