Conflict diminishes focus on jobs data as economic damage risks rise

USD: Impact on labour market could still lie ahead

The movement in yields this week has been all about the potential inflation impact from the US-Iran conflict with the 2-year UST bond yield up 21bps so far this week. The OIS market has seen 21bps of rate cut expectations removed with the market now priced for a 25bp cut and a 50% probability of another. But the fundamentals do still matter and today will be a day of greater focus on the data given we have the release of the February payrolls data. After the surprise strength of the January data (+130k), the consensus today is for a more modest gain of 55k. The retail sales data for January will also be released. But the backdrop to today’s data will be one of rising risks by the day of increased economic damage due to increased inflation.

While the jobs data will still be important today’s print will also be more difficult to read given the potential impact from a strike (Kaiser Permanente), a storm at the start of the month and payback after the positive impact from mild weather in January. While these factors point to potential weakness the flow of data does not suggest there has been any notable drop-off in labour market conditions. The ADP employment saw a gain of 55k while the ISM Services employment index for February came in stronger than expected (51.8). The NFIB Small Business Optimism survey revealed that companies believing it was difficult to fill positions increased from 31% to 33%, still above the long-term average of 24%. Overall hiring plans are improving also. In the consumer confidence report the net jobs plentiful over jobs hard to get index increased by 0.6ppt. The Beige Book for the March FOMC meeting also revealed that labour market conditions were “generally stable” in seven of the twelve districts with wage growth rising at a modest rate in most districts.

But what lies ahead means the overall financial market reaction today is likely to be muted. However, given the concerns over inflation due to the conflict, a stronger print with say stronger wage growth could reinforce the current market momentum and prompt a further reduction in rate cut expectations that helps lift the US dollar further.

The Trump administration is clearly focused on the risk of deteriorating economic conditions and consumer sentiment. The decision to issue a temporary waiver for India to resume purchases of Russian crude oil is the latest example. The waiver is until 4^th April and only includes crude oil already loaded onto tankers by 5^th March. This will have limited impact on crude oil prices as it does not address the primary driver of the price rise – the lack of supply from the Middle East through the Strait of Hormuz. The policing of tankers by the US and the offer of insurance is unlikely to alter the issue.

The waiver only until 5^th April may be seen as the intent of the US to find an off-ramp to cease attacks by then. The impact will certainly worsen and US businesses and households will likely curtail spending as they fear a hit to real incomes as an inflation spike broadens. If the conflict drags on longer today’s jobs data will probably be the best we see for a while and more sustained periods of risk-off would lie ahead. 

NFIB HIRING PLANS INDICATE SIGNS OF LABOUR MARKET IMPROVEMENT

Source: Bloomberg, Macrobond & MUFG GMR

USD: Shifts in rate expectations bigger in Europe

The fears of escalation that translates to higher crude oil and natural gas prices is having a greater impact on front-end yields in Europe than in the US. That makes sense given the upturn in natural gas prices will be a bigger inflation shock in Europe than in the US. The front delivery TTF contract is up 58% this week while the UK future price is 65% higher. The US equivalent is only 2.5% higher. With Qatar production shut this will have a far more severe impact on inflation in Europe. We have also just come to the end of a colder than usual winter in continental Europe which means storage rates for this time of the year are lower than usual.

Looking at Enerdata natural gas production data, the hit from Qatar globally doesn’t look that significant. According to available country breakdown data, Qatar is the 6th largest producer of natural gas accounting for 4.3% of global production. But Iran is 4th (6.6%) and Saudi Arabia is 8th (3.2%). Of the top 12 natural gas producers in the world that account for 80% of total production, 14% of global production comes from the Middle East. While Europe is more exposed to an energy price shock than the US, it has at least diversified its import composition. Norway is now hugely significant for both the EU and the UK. Norway accounts for over 31% of EU natural gas imports. In the UK the Norway import composition is 43% (pipeline). The US has become more important for both the EU and the UK. So the Russia-Ukraine energy shock did prompt a shift to far greater dependence on two more reliable partners – Norway and the US that will help curtail the scale of the price shock relative to 2022. It’s early days of course, but the jumps in prices mentioned above are in contrast to the 5-to-6-fold increases in natural gas prices in 2022.

We could still potentially see further larger increases in front-end rates in Europe given the ECB has cut fully back to a neutral stance. For the Fed and the BoE, the policy stances are still to some degree restrictive. Nonetheless, the macro-economic backdrop could well be more resilient in the US especially given the One Big Beautiful Bill fiscal support in the US that will help US households. Stimulus in Germany is less directed toward households while in the UK there is limited stimulus at all.

So the dollar still remains best placed even though Europe’s energy import diversification will help curtail natural gas price rises to a degree. The impact though will still be determined by the scale of the expected supply disruption and in that regard the ongoing extent of retaliation by Iran does not point to any imminent change in conditions. We feel the market remains reasonably priced for a supply disruption of weeks but each passing day brings the risk of this assumption shifting to something longer and with that further energy price increases and a further strengthening of the dollar.          

EARLY DAYS BUT THERE IS MUCH LESS URGENCY TO HIKE THAN IN 2022

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com