Financial Market Analysis: Bond Yields, Job Growth, and Currency Trends
The yields on treasuries retreated from their highs on Wednesday after the BLS revised the annual job growth in the United States downward, reporting a correction of 306,000 jobs. Some experts had expected a decrease of 500,000. The bond market's reaction, with yields dropping by approximately 10 basis points across all maturities, seemed excessive, but it underscored once again that job growth in the U.S. is currently one of the most critical macroeconomic variables for the Federal Reserve's policy. Even in a scenario where the trend in consumer inflation has reversed, if the labor market remains strong, and consumer spending continues to grow at a solid pace, the movement of inflation towards the 2% target could take time.
This is precisely why the market today has been sensitive to data on unemployment benefit claims. Initial claims grew at a slower pace than expected (230,000 compared to a forecast of 240,000) and long-term claims also exceeded expectations in a positive sense. This allowed the dollar to make a renewed breakthrough of the key mid-term resistance line.
The fundamental backdrop for the euro has worsened somewhat after the release of PMI indices in the service sector yesterday. The data showed that activity in the service sector in the key economy of the Eurozone and in the EU as a whole decreased compared to the previous month.
The trade-weighted euro exchange rate declined by 0.5%, and the two-year EUR/USD swap rate spread (which reflects the expected interest rate differentials between the U.S. and the EU) increased by 10 basis points to 145 bps. This is the highest level since March and clearly has negative implications for EUR/USD. The pair tested the 200-day moving average yesterday, and if it weren't for the negative revision of job growth in the U.S., we would likely have seen a test of the 1.08 level in the pair. It's evident that after the release of leading activity data in the Eurozone, market confidence in another rate hike by the European regulator has diminished, which cannot be said for the Federal Reserve. Therefore, the risks for the pair are certainly tilted towards further decline, as indicated by the fact that the dollar index has exited its bearish channel, signaling the dollar's overall strength.
Tomorrow, the markets are awaiting Powell's speech at the Jackson Hole Symposium, where it is expected that the head of the central bank will clarify whether the recent rise in treasury yields was justified. Clearly, as long-term yields have recently risen at a faster pace, reflecting expectations of longer-term rather than higher short-term interest rates, the market will be satisfied with statements suggesting that rate cuts should not be expected anytime soon. However, if there are hints that the Fed is waiting for inflation to return to the target level by the end of next year and that rate cuts can be expected at that time, the retreat in long-term bond yields could be quite substantial.
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