That hot jobs report and the Fed's September meeting

It's Friday the 4th of September and this is your capital economics weekly briefing. I'm David Wilde coming up, what's going on in energy markets and what about that US Venezuelan oil deal but first, Group Chief Economist Neil Shearing is with me to wait through another week in macro and markets and fresh from burning his hand on that August payrolls release, it's Chief North America economist Stephen Brown. Hi guys. Hi David. Hi David. Let's begin with you. Your preview for the employment report that was released not too long ago said quote unquote, there is scope for some of July's weakness to reverse. How did that work out? Well, yes. I mean, that part of the forecast went very well. Unfortunately, we did also expect some weakness elsewhere due to the government's decision to rescind works data for 315,000 migrants. I mean, that part definitely didn't show up in the data. Instead, we just got this very solid rebound. But I think even that, I mean, we wouldn't want to make too much of that because it probably understates some of the health in August specifically. I mean, it's 162,000 overall surge, bullpark figure, maybe 50,000 of that was a rebound from the kind of statistical quirk in July, but rest looks like more genuine strength, very broad based across the private non-health sector. So we kind of see the three month average gain in the kind of private non-health care sectors actually picking up again now, which is quite encouraging. So what about previous months? Because the July report was a bit of a shocker. You had that negative growth. You had downward revisions from previous months. What does the broader picture of the US employment market look like with all the revisions but all of this latest data factored in? Yeah, I mean, for once the revisions this time to be last two months were actually positive. Again, it wasn't a complete surprise given how weak the July data in particular was. But we no longer have a fall in July, previously that was a 23,000 full. Now it's closer to a 20,000 gain. But yeah, the big picture is that the kind of the three month average change in non-farm payrolls is as close to kind of 65,000 at the moment for private ex-health. It's about 50,000. I mean, most certainly not spectacular numbers by any means, but in the context of a labor market, which probably on net has very little labor force growth because of these very tight restrictions on immigration at the very least, we're seeing payrolls rise at kind of a break even pace enough to prevent any upward pressure on the unemployment rate. And I think more likely we're in the other direction in that payrolls are slowly gradually outpacing the break even. So although the unemployment rate was unchanged at 4.1% in August, we actually saw a bit of downward pressure on the broader U6 unemployment rate. So this includes people kind of working part time for economic reasons that drop back to a 30 month low. So there does seem to be some genuine reasons to think that the labor market is improving and conditions are slowly tightening again. This report was seen as sort of one of the critical data releases ahead of this September Fed meeting. As are in the coming week, these CPI and PPI releases, at this point, could those inflation reports be enough to change this narrative that's forming in the market that a September 16th rate hike announcement from the Fed is, I don't want to say a done deal, but it's certainly looking quite likely at this stage. Well, I think we were talking about this payrolls report being very important, but despite getting this huge upside surprise, I mean market odds for a September hike have, we went up a tiny bit, a couple of basis points, but we're now back at only 13 basis points being priced in it was kind of 12.5 before the data came out. So it really hasn't moved on to all that much and that is because we had Christopher Waller and John Williams from New York Fed this week both coming out sounding quite dovish and saying it wasn't entirely their decision will be almost entirely based on that August price data. But I mean, it is still important from the point of view that it determines how strong that price data needs to be to get a September hike. You know, if we had a slightly above target consistent gain implied for a core PC deflator from the PPI and CPI next week, if the employment report had been weak, that probably wouldn't have been enough to get a hike, but given we've now had this very strong employment report, I think we only need to see a slightly above target consistent gain implied by that data to secure that September hike. So I mean, for us, we are predicting a slightly above target consistent gain in the core CPI, at least it is a bit or more of a struggle to forecast the PPI data. It tends to be a lot more volatile. So although our official forecast is December, I probably will kind of ready to move back to September, which was our original forecast if we do see that price data coming next week. You know, I think another point here though is that there seems to be two groups among the FOMC at the moment. I mean, there has been for several months now, but on the one hand, the likes of Waller and Williams are very much kind of sticking to this point of data dependence, you know, they're going to make their decisions based on the most recent inflation data. Whereas Chair Walsh, you know, he's faced a lot of criticism already in the last few months, but I think one thing that I do find quite encouraging from him is he seems to want to shift away from this idea of basing policy just on the most recent data. You know, the problem with doing that is that you're almost by definition going to end up behind the curve, if you wait for the price data to be showing above target gains in inflation. Whereas if you take a more forward looking approach or, you know, you stand a better chance of getting ahead of the curve and not having to hike by as much, and although the most recent price data up to July have been relatively soft, we've seen, for instance, the ISM surveys this week for prices paid components, both very strong, both manufacturing and services are survey respondents telling us that price pressures are broad-based. All that suggests that the Fed should be hiking to try and get ahead of some of these inflation pressures set to come through. Neil, let me ask you, this debate that Stephen alluded to there on the FOMC, similar conversations going on on the ECB's governing council, on the MPC, the Bank of England's Monetary Policy Committee. The ECB meeting is next week. We've got the Bank of England the following week. The mood music does seem to be very much that inflation risks are still alive, right? Indeed. And I think that's what the data is telling us, too. There's a slight difference with the Eurozone and with the UK, too, compared to the US, which is that the real economy is a bit weaker. And there's particularly the case in the UK, and we've just, we're talking on the back because it's kind of blockbuster non-farm payrolls report in the US, but the labour market in the UK, higher in the UK, has been significantly softer than in the US. So, in a sense, Europe's facing the inflation problem, but it doesn't have the strength of the real economy behind it. There were justify rate hikes as in the case of the US. Now, I don't think that's going to stop the ECB from hiking rates in September at this one's meeting. Because Stephen was talking about what's priced into the market. I mean, that's almost fully priced in that, and there's about 98% chance of a rate hike priced into the market at September's ECB meeting. I think that the Bank of England might be edging towards hiking. We had a very hawkish speech from Hugh Pill, who is one of the more hawkish members of the MPC over the past week, but I think it's probably a bit further from hiking from pulling that trigger than the ECB. But this is, in the case of the Bank of England, in the case of the ECB, this is a response to higher energy prices rather than strong real economy, tight-laven markets, underlying inflation pressures, remaining relatively strong, which is what we'll be driving at a response in the case of the US. How much does, what we've been seeing in energy markets, the resurgence in oil prices and gas prices, in refined product prices, indeed, how much has that changed the outlook for these economies? Maybe Neil, you want to talk about the UK and Europe, but Stephen, I'll be very interested to hear what you have to say about what's going on in the US in terms of gas prices and the like. I think that the first point to say is that in general terms, higher global energy prices is a headwind for Europe, and by that I mean the Eurozone and the UK, in a way that it's not in quite the same way for the US, because the US is a small net energy exporter, but Europe's a still a large net energy importer, so higher global energy prices, economic headwind for Europe, less so for the US. Now of course, in reality it's a bit more nuanced and a bit more complicated than that. The big development I think over the past few weeks has not necessarily been the resurgence in oil prices, but as much natural gas prices, and that's particularly an issue for Europe because countries like the UK price, utility bills, price, household electricity bills offer the natural gas price, so it feeds through to inflation with a like, but it will feed through. So I think we're going to see a further pickup in inflation in the UK, in the Eurozone, to give you a kind of rough ballpark number, every ten dollars on the price of a barrel of oil adds something like 0.1 to 0.2 percentage points to tyranny and inflation if you want to back up the envelope kind of idea. So it's going to push up inflation, it's going to squeeze real incomes, it makes Europe a whole worse off in the way that it doesn't in the US. But of course, in the case of the US, there are winners and there are losers, and you mentioned gas prices. We get a much faster pass through from oil prices to gas prices, also in petrol prices, petroleum prices in the US than is the case in Europe because the tax which is smaller in the US. So this is a bit more of a headwind for US consumers. run up to the midterms. Now with all that being said, I wouldn't overpay the macro consequences of the moves we've seen in energy markets over the past few months or too much. They're ready to be sworn in the ground scheme of things. The big picture is that energy prices are still a bit higher than they were. The start of the summer but not dramatically slow. I don't think it really was a big shift in the macro view. What matters really is whether they start to come down over the next 12 months or so as potentially supplies from the Middle East are restored. That remains our base case but we are pushing up. We have pushed up our end-year forecast for oil and for natural gas. We now think Brent crude ends the year but our $100 a barrel, natural gas at 80 euros per megawatt hour. I come down to about $70 a barrel on oil by the end of next year. So it's a bit more for steady decline. It's a bit more of a headwind of the year but I don't think it fundamentally changes or should change the calculus on the Bank of England's NPC or the ECB for that. Just to add to that, I think one thing that is interesting. Neil mentioned how the recent move in energy prices hasn't been that great but I think compared to some central bank as original assumptions it is a bit more about how long energy prices have now been elevated. We heard from Bank of Canada this week they kept interest rates unchanged but they delivered a more hawkish statement largely because of this point that energy prices don't seem to be dropping back and based on our forecast they're not going to drop back anytime soon either. So even central banks like the Bank of Canada where the economy is relatively weak are getting more concern now about the risk that because energy prices have been higher for longer the chance of them bleeding through to other prices is increasing. I think what's particularly interesting for the US and Canada is although we tend to put most focus on gasoline prices, it's actually diesel prices that have risen the most. So you are potentially in the situation where because the consumers are not facing quite as large gasoline prices as firms are in terms of fuel costs that actually allows firms a bit more scope to pass on those higher diesel costs through to the consumer. So we're faced with a situation where it could be a bit of food and goods prices pick up a bit more than if consumers were also facing the same size hit from kind of much higher gasoline prices as well. In the mix of all of this of course and we started the week with bonds selling off globally quite intensively as we perhaps call a little bit as we as we near to the end of this week but the fact is that yields for some government bonds, long term government bonds at the levels they haven't seen in decades. How is this playing into the macro environment Neil? Let me ask you first what I guess the key question or A key question is have we seen the end of it in terms of this latest sell off in the bond market but also does it change the calculus for policy makers thinking about the central banks getting ready to gather together and make their latest decisions? Well I think it's helpful to think about what's been driving the the sell off in bond market. It's not just over the past week but really over the past few months because I think there have been two distinct parts that the first part of the sell off which happened at the start of the summer was really about, it was really concentrated at the long end of the curve and was about an increase in term premier. In bonds we've spoken about on the podcast before we've written about it a lot. This is the premier that investors demand for holding bonds over and above the expected path of short term interest rates over the lifetime of the bond and it probably reflected the number of things but before most amongst those I think we're growing concerns about fiscal trajectories across advanced economies. It did not reflect a repricing of inflation risks. We didn't see inflation expectations for example embedded in bond markets in increase. Now over the past week or so that's shifted a little bit because the sell off that we saw at the start of this week was really concentrated at the short end of the curve and it was about markets repricing interest rates over the next year or so, so pricing them higher. And that's about central banks' responses to perceived inflation risks and I think the washes, speech, projects and whole last week set the scene for that was a bit more hawkish in tone and I think that set the scene for that pressure at the short end of the curve. Two distinct parts of the sell off, one to do with higher term premier related in part to a greater perception of fiscal risk and then more recently a sell off at the short end of the curve which is about greater inflation risks and higher short term policy rates over the next year or so. Now how does all that play into the policy characterless was your question and I notice we've been talking and we've had signing off from the usual suspects including President Trump saying that these super strong payrolls numbers justifies lowering interest rates. Kevin Hass has been on CNBC talking up the case for the Fed not moving in September. So there's no need for the Fed to move. This is exactly the type of response that the central banks don't want. They don't want any more institutional pressure on central banks. They want to be left alone to do their job because independent to the extent that independence is seen as being compromised is going to add to that term premier that I've been talking about in bonds and push up yields even further. Ironically these kind of interventions from Hass said these interventions from Trump risk doing exactly what they don't want to happen which is push up interest rates even further if they are smart. The best thing to do is just stay stay quiet. So it's possible that central banks reflect on that and decide actually the best thing to do if you're the Fed is to move in September because that would absolutely end up in the bud any questions about independence being compromised. So in a strange way the pressure on the Fed to keep interest rates unchanged in September in spite of the strength of the strength of the data from politicians and from President Trump may actually lead them to the view that they should raise in September. Raise rates in September because that defends their their independence that actually helps the quill some of the young resting bond markets. Yeah just to add to Neil's point there I mean in terms of timing you know there does to be it seemed to be a sense even from the more damaged members that they are prepared to vote for a high eventually I mean with the kind of political awkwardness would be even more awkward if they waited for October because then October meeting is just a few days before the midterms. So I think there could even be a sense among those people that if there is a slightly above target consistent rise of enterprise data next week where that probably makes sense to just move in September rather than potentially having to wait until December or giving a signal that they are being influenced by the political calendar. Neil Shearing and Stephen Brown there on the latest US jobs numbers a global inflation risk central banks and what's happening in bond markets. We've got a load of drop-ins which are our short form online briefings happening in the coming weeks to help clients navigate these complex macro and market risks. The next ones are on Tuesday the 8th of September straight after Labor Day in which Chief Global Economist Jennifer McCune will lead a panel of senior economist answering questions on everything from where rates are going to when the AI bubble might burst to key upcoming events such as the next Trump sheet meeting and October's UK budget. I'll link to those events in the podcast notes. If you're not a capital economic subscriber and you want to know more about these briefings along with the rest of our global macro and market analysis head to our website capital economics.com and start your free trial today. Now I mentioned in that conversation about how our commodities team has raised their oil and gas price forecast. The team actually briefed clients in a drop-in this past Thursday to talk about the outlet for crude oil, for oil products, for gas, for gold and much more besides. There's an edited excerpt from that briefing in which you'll hear David Oxley, Hamad Hussein and Kiran Tomkens and it begins with Kiran talking about how the crisis in energy markets has moved to refined products. So it's been a very key development that petroleum products have essentially become the main pressure point in the oil market. Product prices have kind of risen considerably more than crude oil prices. This is the start of the war, crack spreads across several regions of climb back towards levels last seed in 2022 and these increases have been most acute in the US, closely followed by Europe. Meanwhile, for products, these spreads are generally largest diesel and in certain products and regions is crack spreads, which are the difference in the price between refined product prices and crude oil are actually higher than the price of crude oil itself. In other words, in some places, product prices around double the price of crude oil. For example, in New York and the US Gulf Coast, the price of diesel has reached $205 per barrel in recent days. So the bottleneck is not simply just the availability of crude oil itself, it's also the ability to turn that crude into the right products and deliver them to the right markets. And these product markets have tied and considerably for a few different reasons, the disruption to tank traffic through the straight form is has affected oil product markets more severely than crude because crude export has had a greater scope to use pipelines that bypass the straight. There are fewer alternative bypass routes for refined product exports. So through the combination of this shuttling that's been going on in the straight over the last few weeks, as well as these bypassing pipelines, it means around about 60 to 80% of pre-war crude flows have now returned by contrast. the flows of petroleum products are still largely curtailed. And then on top of that, there's been a second major shock in the form of developments in the Russia-Ukraine war as well. So Ukraine, through joined strikes, has attacked a very substantial share of Russia's refining capacity, leaving large swedes of it idleed. And so that has cut into the availability of gasoline and diesel. Indeed, Russia actually has at several points throughout the summer extended diesel export bands and has become an importer of gasoline. And there's really no kind of easy fix for refiners elsewhere either. They do have the option to kind of like alter their product yield, what they produce at the margins. They did this at the beginning of the corrupt crisis to help alleviate some of the strains in the jet fuel market. But gasoline and diesel markets are considerably larger, so these modest changers and how they set up refineries to what they can actually produce just simply cannot fully offset a major loss of regional supply. So it sounds like the crisis has morphed and I think if you're looking for where the shock is, if there was other shock has been where a lot more acute in oil products than the crude market, the thing. The other question I was trying to jump in was just a question about how this relates to the risk of physical shortages of particular products, particularly in Europe over the coming months. Yeah, well, I guess there's a question of classification there to begin with. When is the shortage of shortage? Some might think of it in terms of there being a physical scarcity of it somewhere. But for us economists, I think we see the first signs of it coming through the price mechanism before that point where high prices deter price sensitive consumption. And on a related note there, these elevated products breads that we're seeing mean that consumers are facing higher fuel prices, even without an equivalent rise in the price of crude. Therefore demand disruption will probably actually occur at a lower price of crude oil than otherwise. And then even looking beyond that where physical scarcity may arise, it's probably more likely to occur in regions with less ability to pay. So probably looking at sways of Africa and maybe Asia before shortages in the sense of a scarcity occurs in Europe. I'm telling you, as I see, apart from crude oil products, natural gas has also clearly been affected considerably by the hormones crisis and the disruption to the guitarry production of LNG. We've just raised our NDA forecast for EU natural gas and Asia LNG as well. Could you just talk through some of the perfect storm of factors that have faced natural gas? Now we see that plan out. Yeah, thanks David. There's a few things going on in the natural gas market. So first of all, what we're seeing or rather what we're not seeing is any sort of flows of LNG coming out of the straight of hormones. So whereas a lot of ship to ship transfers have been taking place transporting oil out of the straight of hormones to the tune of somewhere in the region of six to eight million barrels per day according to various estimates. There seems to be only based on media reports and various different industry estimates, only a handful of LNG ships have left the straight over the past couple of months. So we're not seeing some of the supply constraints in the LNG market be offset by shutling in the same way that we're seeing it in the crude oil market. The other sort of factor that's at play is sort of the current level of EU storage. So EU gas storage is currently around 65% at the minute and that's a seasonal low for over 10 years. It leaves Europe in a bit of a pickle rarely. They could step on the gas if you put them upon and accelerate purchases of LNG and fill up storage ahead of the winter but of course I'll put up a lot of output pressure on prices right now or they can sort of sit out going to the winter with storage levels below the 80% target that the EU aims for and hope for a mild winter. This is where gas consumption is weaker than in previous years. So I think either situation really is pointing towards gas prices going higher which is why we've revised our price forecast so we're now expecting EU natural gas prices to reach 80 euros per hour at the end of this year. There's a couple of factors that could sort of exacerbate that so if we get sort of a colder than usual weather could push prices higher and other factors if we don't see perhaps demand destruction in Asia so far throughout this sort of prices in the Middle East Asian LNG buying has been relatively strong we've not seen high prices to tear Asian buyers as one would have expected so if we don't see sort of Asian demand destruction over the coming months perhaps that could lead to tighter competition for LNG cargoes and also push up prices as well. So yeah that's really the outlook over the next few months. Great thank you and just turning away from hormones I mean they're either world away from hormones believe it or not and we've had quite a few questions about the Venezuela deal with the US it's been announced here and could you just talk us through what has been announced and yeah just how big a deal it could be. Yeah there's been a bit of a flurry of news in an announcement on Venezuela oil deals over the last week and the largest has been the deal announced by the White House announced on Friday and then some more details of it came out on Monday and it's interesting that the White House itself actually framed this is the US taking control of oil reserves in Venezuela it talked about establishing the US's energy dominance and the Monroe doctrine as well and the details that we found out is that the US is going to receive an equity stake in this company called North American Blue Energy Partners which has been granted access to oil fields in Venezuela that contain apparently 65 billion barrels of oil reserves. The US will have the right to purchase 20% of any production at cost price and a first right of refusal to buy the remaining 80% of output too and then on top of that but separately there's also been a couple of other oil deals announced yesterday and that included Chevron committing to invest 7 billion over the next five years in order to double its oil production to 600,000 barrels per day and while Trump has used this announcement to help the idea of it bringing down gasoline prices in the US and the near term that's pretty unlikely it would suggest a back in January February I think it was that a number of short-term wins could raise Venezuela's oil output by about 0.3 to 0.5 million barrels per day by mid to late next year and it seems as though output has increased by 0.2 million barrels per day so far but further gains in output will be harder to come by require more time, more investment and will certainly be longer than Trump's time frame. After all Venezuela's infrastructure has deteriorated after years of underinvestment and poor maintenance so the gains that can be juiced out in the short term you know they just they won't be close enough to offsetting this output pressure on prices from disruptions in the Middle East and looking beyond that whether there is a sustained recovery probably depends on the extent of institutional reform and the improvement in investment conditions and property rights that are needed to coax producers back on a sustained basis but taking a bit of a step back in in the US trying to create a pretty hefty signal with this big oil deal that Venezuela is investible I think the US government might actually have muddied some already murky waters about whether Venezuela is a good opportunity for oil majors and I think there's a major risk that the US is framing of this deal kind of risk some domestic backlash against the incumbent government in Venezuela and by extension probably are some longer-term risk for oil majors to consider that was Kirin Tomkin's hammer to sane and David Oxley on energy markets including that US Venezuela deal you can watch the full briefing by clicking on the link which I'll add to the podcast notes but that's it for this week next week's show is going to be a special all about China shock 2.0 we've got a load of analysis coming up about whether this is how the next global economic or financial crisis starts Neil's going to be on the show to talk all about that so until then goodbye