Weekly Investment View: Is the US Labour Market Still Resilient Despite Policy Uncertainty?

This Week

• US Macro – Dominique highlights the Fed’s rate decision and US jobs report, with policy expected to remain on hold amid our model calling for a large positive NFP surprise.
• China – Liang expects the PBoC to increase liquidity provision, with market conditions making this an ‘opportune time’ for China’s central bank to resume bond purchases.
• EZ and UK Macro – Henry is focused on Friday’s Eurozone July HICP inflation release, retaining the view that the medium-term inflation outlook is hotter than ECB policy is consistent with.
• G10 FX – Ben attributes the recent EUR/USD selloff to current account considerations and the market protecting positions in the pair. Long term, we see EUR as one of our favored longs.

Dominique Dwor-Frecaut – US Macro

Besides the Fed that has signalled it will remain paused, this week’s most important data is the employment report as it will provide an update on business demand and inflation pressures. Sam’s model expects a large positive NFP surprise relative to consensus of 107k but unemployment to remain roughly unchanged. If so, it would signal that labour demand and supply remain resilient despite current policy uncertainties and sharp declines in immigration.

The Fed is concerned by price increases becoming a lasting inflation acceleration, rather than by the price increases themselves that are unavoidable given the tariffs’ magnitude. Wage growth is key to assess the risk of broad-based inflation acceleration, but wage growth has been slowing for the past three years, and consensus expects only a 10bp YoY increase in July. Consensus also expects Thursday’s Q2 employment cost index, which accounts for changes in the distribution of wages, to slow further and confirm the benign wage growth trends.

Chart 1: Wage Growth, Unemployment Consistent With Continued Disinflation

Liang Ding – China

The unexpected surge in commodity prices following the government’s effort to curb oversupply raised inflation expectations. It led the CGB yield to surge, especially at the long end. However, stronger demand-side supports are necessary for a sustainable price improvement, given expected H2 economic headwinds.

Whereas in the last three episodes of coal production curbs, the negative PPI was entirely driven by the upstream and intermediate material sectors, the negative price development in the downstream and intermediate equipment sectors has currently contributed 20% of the negative price development (Chart 2). Lowering upstream production pre-emptively to the expected demand shock is necessary, but insufficient to keep the price stable.

We expect the PBoC to increase liquidity provision since it indicated the 10-year CGB at 1.67% is fair. The current liquidity withdrawal from mutual funds and security companies could meet the PBoC’s definition of an ‘opportune time’ to resume bond purchases. The current yield differential between the 10-year CGB bond and the 1-year AAA NCD bond reached a YTD high of 7bp. This makes CGB attractive for the banks. We expect the 10-year CGB yield to stabilise around 1.70%.

Since the third round of US-China trade talks was announced a week ago, the RMB has traded strongly, supported by a robust equity market and a strong RMB fixing against USD. However, considering the recent tariff announcements (15% for US allies, 20% for ASEAN countries and 40% for transhipping goods) limited scope exists for substantial tariff reductions in the Stockholm negotiations. Currently, the average US tariff on Chinese imports stands at 40%.

Near term, an increase in export growth in July and decreased FX hoarding by exporters and households still support RMB. However, as trade flows are expected to become less favourable for non-US countries in coming months, the ‘sell US’ narrative may lose momentum. RMB’s high sensitivity to trade surplus data could lead to renewed pressure on the currency.

Chart 2: PPI Breakdown and Three Rounds of Coal Production Cuts

Henry Occleston – Eurozone & UK Macro

This week’s main event is Eurozone July HICP inflation released on Friday. Core CPI and services remain strong YTD – they will be the more important outturns. However, we would not overemphasise a single reading, particularly before the detailed final release, especially the progress in wage-intensive services inflation (Chart 3).

Before the aggregate release, national preliminary releases start with Spain on Wednesday, followed by France and Germany on Thursday. We watch for continued YTD overshoot in services and core. Also, labour market tightness is important medium term. Thursday sees the Eurozone unemployment rate, where we expect trend tightening to continue due to demographics and Germany’s less generous Ukrainian refugee benefits.

ECB CPI expectations released this morning showed inflation expectations remain high and unanchored versus pre-2022, with the 3Y outlook still running at 2.4%. This aligns with our view that the medium-term inflation outlook is hotter than ECB policy is consistent with.

Chart 3: EZ Wage-Intensive Services Inflation

Still Running Hot

Ben Ford – G10 FX

EUR/USD is down again. It is the pair’s 16th worst two-day period of the past decade, with 12 May the only worse day in the past year. Three takeaways:

1) This is a current account shock. The US-EU current account differential could tighten by 3pp of GDP (Chart 4). If President Trump continues getting current account shocks, being short 1) CNY, 2) EUR, 3) MXN, 4) TWD, 5) JPY, 6) KRW and 7) CAD against 1) AUD, 2) BRL, 3) GBP, 4) SGD, 5) COP, 6) NZD and 7) NOK can outperform.

2) The market is protecting EUR/USD positions. Yesterday saw 1.1550 puts favoured. Previous USD declines have frequently seen larger-than-3% corrections. A 3.5% move would take us to 1.14. More broadly, we expect EUR outperformance to peak in coming months for four reasons:

A) Mean reversion.

B) Equities tire out.

C) Tariff realisation enters the chat.

D) Political risks return.

3) Long term, we still adopt the Hou, Sarno, Ye (2023) framework, which signals to be long CAD, CLP, EUR, MXN and TRY, and short CHF, CNY, KRW, SGD, THB.

Chart 4: Current Account Deficit to Tighten

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