Mini-“tantrum” in bonds doesn’t shake global equities

Brian Nick

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Quote of the week

“Choose a job you love, and you will never have to work a day in your life.”—Confucius

The Lead Story: The economy continues to crank out jobs. But where are the wage gains?

The U.S. labor market generated an above-consensus 222,000 jobs in June. In addition, payrolls for April and May were increased by a combined 47,000. Headline unemployment ticked up to 4.4%, and the U-6 “underemployment rate” also rose, from 8.4% to 8.6%, but for a good reason. More people declared themselves to be part of the labor force and sought gainful employment, increasing the labor-force participation rate to 62.8% from 62.7%.

If June’s report tells us anything, it’s that labor market conditions may not be as tight we think. That’s one reason higher average wage growth remains elusive: wages improved by only 0.2% in June and 2.5% compared to a year ago, well below what we’d the rate expected at this stage of the economic recovery.

It’s important not to overreact or draw sweeping conclusions from this one release. Unemployment rates have been dropping like stones in recent months, and this is probably a pause in that trend. As for the Federal Reserve, June’s employment numbers help confirm what policymakers have already suspected, namely, that the economy is on solid footing. At the same time, the lack of serious wage pressure, which has helped keep inflation low, allows them to continue their gradual pace of tightening. We still expect one more rate hike this year, in December.

In other news: Some mixed messages from U.S. manufacturing

In addition to June’s jobs report, this week’s lineup featured several key U.S. data releases:
  • U.S. manufacturing activity jumped to 57.8 in June, its highest level in nearly three years, as measured by the ISM Purchasing Managers’ Index (PMI). While ISM readings have remained comfortably above the 50 mark separating expansion from contraction since last December, a similar indicator from Markit has shown the sector weakening over the same time period.  
  • Factory orders fell by a more-than-expected 0.8% in May, their biggest drop in six months.
  • Service-sector activity quickened to 57.4 in June, according to the ISM’s non-manufacturing gauge.
  • The U.S. trade deficit narrowed by 2.3% in May, to $46.5 billion, as exports hit their best level in more than two years.

The Eurozone’s manufacturing and services sector concluded their best quarter in six years, according to Markit’s PMI. While inflationary pressures have cooled since earlier in the year, rising demand for goods and services has boosted firms’ pricing power, an encouraging sign as the European Central Bank (ECB) aims to lift inflation. Moreover, the region’s four-largest economies all reported faster growth during the quarter, adding to a picture of an increasingly self-sustaining recovery.

Below the fold: Rising yields mean a rough week for fixed-income investors

The week was marked by a further rise in global yields, driven partly by soft demand for European government bonds. With the Eurozone’s economy continuing to improve, markets have been anticipating the ECB’s decision to begin scaling back its aggressive quantitative easing package. The yield on Germany’s 10-year government bond closed the week at 0.57%, its highest level since January 2016. (Yield and price move in opposite directions.) Yields on Italian, Spanish, and French sovereign debt also rose. 

The move in European yields has been compared to the so-called “Taper Tantrum” of 2013, when the Fed hinted at the end of its bond-buying program. Thus far, however, the cumulative increase in interest rates is still relatively small compared to the 150 basis point (1.50%) jump in 10-year U.S. Treasury yields we saw during that time.

U.S. fixed-income markets have been taking their cues from Europe. Despite a series of below-consensus data releases over the past few weeks, the yield on the bellwether 10-year note has grinded higher, closing at 2.39% on July 7, a jump of 25 basis points (0.25%) since June 26. In our view, the 10-year may well approach 2.60% over the summer. Geopolitical shocks, however, could briefly reverse that trend; investors often seek the safety of U.S. Treasuries during times of stress, stoking demand and sending yields lower.   

With June’s better-than-expected jobs data providing some late-week support, the S&P 500 Index finished with a small gain during the holiday-shortened week. Europe’s STOXX 600 Index also advanced modestly in both U.S. dollar and local-currency terms.

Back page: We see green shoots in Brazil

Brazilians are frustrated—and who can blame them?
In the latest in a seemingly never-ending string of corruption scandals, the nation’s current president, Michel Temer, who replaced impeached president Dilma Rousseff last September, has been accused of authorizing bribes. Should he be removed from office, former president Luiz Inacio Lula da Silva (“Lula”) is a favorite to replace him despite also being under criminal investigation. These developments coincide with Brazil’s attempt to emerge from a brutal recession. 

But the news from Latin America’s largest economy is not all bad, as we see signs of “green shoots”:
  • GDP grew at a 1% rate in Q1, , its first quarter of positive growth in over two years. 
  • Industrial production increased by 4% over the past year, its highest annual gain since February 2014.
  • Auto production and sales figures rose in June by 13.5% and 15.1%, respectively, compared to a year ago.

Brazil’s currency, the real, has lost nearly half its value from its most recent peak in 2011, badly damaging foreign investment demand but also making Brazil’s exporters more competitive in the global marketplace. Real interest rates in Brazil are among the highest in the world, with local currency 10-year sovereign debt yielding 10.5%. Equity valuations sit at 30% below their long-term averages following a stock market sell-off triggered by the announcement of the Temer scandal.

All told, we would like to see stronger and more durable signs of an economic recovery bolstered by reforms, and the political turmoil certainly does not inspire great confidence in this regard. However, even the current government has made progress by instituting a spending cap on the federal budget. Hard choices surrounding much-needed labor and pension reforms remain, but we expect they will be handled by the next administration, which should benefit from a sturdier political foundation and, in all likelihood, stronger economic growth. Against this backdrop, there are opportunities in Brazil for long-term investors.
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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