Top of the Morning: CIO Strategy Snapshot - Where to from here?
The desk maintains a cautious outlook on US economic data following a surprising July payroll report, which recorded a significant miss with job growth at just 73,000 and notable downward revisions to prior months. Per the full note source, the average monthly job creation has decreased dramatically to 35,000 over the last three months, raising concerns about potential economic slowdown and its ramifications for future Federal Reserve policy. Market participants should remain alert to the implications of these figures as they navigate the upcoming trading days, especially given the correlations between economic indicators and FX volatility.
What the desk is arguing
The desk argues that the recent payroll data signals potential economic weakness, implicating a bearish sentiment as markets react to diminishing job growth figures. The payroll increase of 73,000 was notably lower than the expected 110,000, while downward revisions from prior months contributed to a loss of confidence. Per the full note source, this correction means job growth averaged just 35,000 over three months, which is stark compared to higher expectations.
Supporting this argument, the significant revision of 258,000 jobs over two months is among the largest seen in years, absent the pandemic period. With improved labor market data being a linchpin for Fed policies, these findings may temper expectations of aggressive monetary tightening, thus influencing the FX landscape as traders reassess potential shifts in interest rates.
Where it sits in our coverage
Our consensus target for USD/CAD stands at 1.075, with ranges from a low of 1.04 to a high of 1.12. Among the firms, jpmorgan aligns with this perspective at a target of 1.10 for Mar26. On the contrary, bofa offers a more bearish stance with a 1.04 target for the same tenor.
This desk's view aligns with the consensus range, positioned centrally at the target midpoint. It reflects a cautious adjustment in light of deteriorating job growth figures, which may influence subsequent FX strategies.
How other firms see it
Firms such as jpmorgan and others align with a cautious outlook on USD given softening domestic data. Conversely, bofa takes a more pessimistic view, projecting lower targets for the pair as market conditions evolve under Fed scrutiny.
Watch for movements in the USD/CAD and EUR/USD as they may reflect the projected impact of U.S. economic indicators and Fed policy on international markets. The USD/CAD dynamics will be particularly telling about trader sentiment towards U.S. monetary policy.
01July payrolls missed estimates significantly, with new jobs at just 73,000 against a forecast of 110,000.
02Downward revisions totaled 258,000 jobs for May and June, reflecting severe economic concerns.
03The three-month average job growth has fallen to just 35,000, indicating a potential slowdown.
04Implications for Fed policy suggest a less aggressive monetary tightening stance going forward.
Market implications
Traders should closely monitor USD/CAD around the 1.07 level, where price action may indicate how the market digests the weak payroll data. Any further economic reports will also be significant in shaping expectations for the Fed's next move.
Risks to this view
If subsequent economic data shows resilience, or if inflation metrics suggest the need for continued tightening, the bearish outlook could be invalidated, leading to potential adjustments in interest rate expectations.
ubs
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. Last week was expected to be eventful with critical economic data, the Fed's FOMC meeting, the August 1st deadline for trade deals, and of course, plenty of Q2 earnings reports.
The week did not disappoint, although in unexpected ways, which contributed to the S&P 500 falling 2.4%. So, joining us on this Monday morning to discuss this all, glad to welcome back Head of Asset Allocation for the Americas with the UBS Chief Investment Office, Jason Draho. Jason, good morning.
Thank you for dropping by and for spending some time this morning with our listeners. Welcome back. Good morning, Dan.
Happy Monday. Good to be here. So, let's begin with the economic data, and in particular, the July payrolls report.
What were the main details and what does it all say about the health of the economy at this time? Well, this is one of the data points that I think surprised in unexpected ways and disappointing ways. Payrolls in July rose $73,000.
That was below the consensus expectation of about $110,000. The real story was the downward revisions in the May and June jobs number. For June, it went from $133,000 to only $14,000.
For May, it went from $125,000 to $19,000, so a combined total of $258,000 reduction in jobs. That's the biggest two-month revision outside, I think, of the pandemic that we've kind of seen in many years. You know, these revisions are split between public and private sector.
We know some of the data for June in particular was kind of funky because there was a big increase or a big part of the job increase was related to education, which doesn't really make sense of higher increase in education during the summer vacation season. One of the implications is that now the three-month average monthly job growth went from $149,000 based on April through June. Now May through July, it's down to $35,000, so kind of a much weaker number than sort of previously assumed.
So overall, the story from the labor market report is that lots of things are holding up well. I think that takes definitely a bit of a hit, and that's why we saw the markets react the way they did. So you're not cracking or like, you know, terrible, but it's certainly weaker than us investors, the Fed, had been assuming.
Other data points last week also sort of pointed to some softness, such as like the ISM Manufacturing Survey. In the Q2 GDP report, the number was good around 3%, but there was a lot of volatility in the first half GDP numbers because of swings in inventories and exports were causing big shifts. Under private sector, final demand, though, grew only 1.6% annualized in the first half, which is compared to a lot of past couple of years where it's around 3%.
So consumption is also kind of slowing notably. And even outside of AI investment, the rest of investment is basically flat. It's not growing.
So definitely signs of weakness overall. That weakness in the labor market report in particular is also why President Trump on Friday made the decision to fire the head of the Bureau of Labor Statistics that's responsible for producing the jobs data. That's just a data collection kind of process.
There's no policymaking decision. So it's a bit of a worrying sign that you're firing someone about the quality of the data when it's not necessarily their fault, perhaps. But that's kind of where we are right now.
Again, a weaker picture on the labor market, and now there's actually more uncertainty about just perhaps the quality of the data we're going to get going forward, not only on labor market reports, but the BLS also produces CPI data. So I think this is just adds to the anxiety that investors have. Weak data, but also kind of questionable direction ahead of what the quality of the data is going to be like.
Yeah, some very interesting developments there. And if we turn now to the Fed, the central bank did not cut rates, which was the expected outcome as we talked about during last Monday's episode. However, on Friday, this was interesting.
Fed Governor Adriana Kugler resigned, and the weak jobs data begs the question of what's the Fed's policy path going forward? So Jason, what's your expectation for the Fed from here? Well, the Fed didn't cut.
That was expected. There was two dissents, people who wanted to cut. That was also kind of expected.
There was sort of a perception after J-PAL's press conference that he was a bit hawkish. But he did note six times during that the economy faces downside risks under the tariffs to have a one-time impact. So at least you can interpret that he is setting things up for the potential for rate cuts going forward.
You know, after the meeting, the market pricing for September cut was down to about a 50% chance. December was, or through the end of the year, so through December meeting, it was down to about one and a half. After the jobs report on Friday, now we're almost fully pricing in one full cut for September and back to roughly two cuts by December.
So the market definitely shifted based on the jobs data being weak, but also given now the possibility or the likelihood that we will get a replacement for Kugler quite soon. This kind of matters, just more in terms of perhaps the timing of how quickly the Fed is going to move. The expectation that we had, like a lot of the people in the market had, is that her term was set to expire in January.
By the fall, the Trump administration would announce the replacement for that position, which normally wouldn't garner a lot of attention, but the thought was they would announce the person who would take that role, and that person would be the Fed chair in writing and take over from Jay Powell starting in May. Now that Kugler has resigned, the Trump administration can announce a candidate within weeks before the end of August. It still has to go through the standard confirmation hearings, but that role could be filled before the next FOMC meeting in September, and then you have a situation where the presumption will be that that person will be the next chair, so you have essentially the current chair, and then for eight months, the shadow Fed chair, a person who will probably be more dovish than Powell.
In the near term for the rest of this year, it may not change the path of what the Fed is going to do, especially if the economic data warrants cuts, but it just creates additional noise or confusion of the other person speaking. What does it mean for Fed policy beyond the next meeting? What kind of policy frameworks are they going to choose?
What does it mean for a broad scope of Fed things for the Fed undertaking, which won't happen and can't happen until after May? So again, it's another thing that investors have to, you know, may not change much, but it just adds a little bit more uncertainty of, you know, what happens from here. And of course, the markets don't like that uncertainty.
Now, Jason, if we turn to trade, focusing on trade deals, some were reached by the August 1st deadline last Friday. However, for countries that did not agree to a deal with President Trump, tariff rates, of course, went up. So how does this impact the outlook for where tariff rates end up from here?
Well, there's, you know, maybe optimism in the markets after deals were announced with Japan and the EU on a prior Sunday with the August 1st deadline looming. You know, there's a couple of additional deals, but a lot of things that actually didn't, you know, weren't reached and therefore tariff rates went up. You know, in general, these new higher tariff rates are lower than what was announced back on April 2nd, you know, or the rates, you know, proposed in letters that Trump had sent to different countries earlier in the month.
But they are generally higher than the 10% baseline that has been in effect since April. So there's trading partners that will have now a 15% tariff rate applied. That covered about 30% of imports from the U.S.
Those above the 15% tariff rate account for another 20%. And countries, you know, right at 10% account for about 8% of imports. So, you know, it definitely kind of takes it higher.
You know, there is a reprieve for Mexico. There's a 90-day reprieve before the tariffs go higher. That wasn't the case for Canada, where tariffs went up to 35% already on August 1st.
But a large majority of the goods coming from Canada, you know, are already sort of exempt under the USMCA. So it may not have a big impact, but again, it just sort of directly creates some uncertainty. The key thing to focus on is the effective tariff rates, you know, when you apply it across all different goods, like what is effectively the rate that's being paid for imports.
Our base case is that it would settle around 15%. This probably pushes a little bit higher in the short term. The budget law puts it around 18.5% currently.
Now, some of these tariffs ultimately could be negotiated down, like for example, the ones with Canada. But it may be the case that, you know, the economy has to get worse, the markets have to get worse, to sort of incentivize, you know, President Trump to want to lower things as a form of like announcing we've got deals up or they can bring it down to reduce the drag on the economy. So we still think ultimately it's going to end up in that 15% effective tariff rate, it will probably be bumpy over the next few weeks, next, you know, couple of months before probably settles out before the end of the year.
So Jason, if we end on the markets, was the decline in equities last week a temporary blip or should investors expect more volatility and weakness from here? Well, you know, our last house you updated a couple of weeks ago, we had one of our key messages was prepare for volatility. It turned out that began the following week, and I think that's the reasonable expectation certainly for the rest of this summer, and it's not probably going to change in the next month or two.
Again, economic data, it's likely to get a bit worse with communities and weakness on the labor market. The impact of tariffs is, you know, should start to show up even more as we go into the fall. First with inflation data, and we get July inflation data on August 12th.
So that's, you know, the direction travel. I think ultimately, too, investors have real confidence that there'll be a slowdown growth but not a recession, that things will start to reflect, you know, better next year. And you see policymakers pivoting, or what I would say is like they, you know, exercise their put.
Until that happens, I think there's at least some anxiety in the marketplace. I wouldn't expect significant downsides, you know, decent pullbacks are probably going to be bought by the markets as the risk will become, you know, more compelling. We remain sort of constructive on the medium term, but in the near term, this is a likely environment, some choppiness, and maybe it will probably require policy shifts, you know, for investors to really become, you know, confident that it's a stormy seas, but it's not a, you know, economic hurricane that's going to really do significant damage.
So kind of keep that in mind. So focus more on the medium term, prepare for this volatility, focus from an equity perspective on sort of secular stories that are less tied to this, such as AI. And rates, you know, rates kind of came lower, all these growth concerns, but there's still certainly a risk that if things stabilize, you know, the back end of the curve could end up going higher, especially if the perception in the market is that you will have a more dovish Fed that could lift inflation expectations going forward.
Well, Jason, very much appreciate the timely perspective, insights, given the interesting week, big week we had in the markets last week, and thank you very much for carving some time out of your personal travels this morning to kick off the week with our listeners and our clients. So great speaking with you, Jason, and look forward to continuing our conversation again soon. You're welcome.
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