Labour Market Gap

The strength of the US labour market was confirmed last week: job creation is strong, wage growth is not consistent with a swift deceleration in services prices, while the high participation rate in the “belly” of the US workforce suggests the reserves of residents who could replace an interrupted flow of immigrants are scarce. The Fed is further validated in its decision to pause. None of this is great for the US bond market. Long-term (and short-term) rates remain higher than in the latest CBO forecasts for the US deficit, which adds to the risks of further drift. The White House has informally issued its tax plans: they are aligned with Donald Trump’s electoral platform. We continue to think that solving the fiscal equation is going to test the new President’s grip on his party. The disagreement between Senate and House Republicans on how to tackle the budget process is a warning shot. “Out of the box” ideas to provide the administration with some additional budgetary room for manoeuvre, e.g. playing on the Treasury’s gold reserves, are a symptom of the depth of the fiscal conundrum the US is facing, and despite the 30-day reprieve granted to Canada and Mexico, we continue to expect some more substantial lift in overall US tariffs beyond the 10% levy on Chinese products, given the role tariffs’ income plays in the fiscal plan of the administration. Conversely, the latest quantitative and qualitative indicators released by the ECB suggest the European labour market is softening fast, and that a steep deceleration in wages is ahead. The latest ECB Corporate Telephone Survey also suggest European businesses consider – unlike the ECB hawks – that trade wars are deflationary, not inflationary. All this continues to push in the direction of more accommodation from the central bank, while the “EU leaders’ retreat”, at the beginning of last week, has not produced breakthrough decisions (at least not yet). Last week, the Bank of England chose to cut by 25bps despite raising its inflation forecasts. One usually hawkish MPC member even sided with a dove to call for a 50bp cut. This is another sign that, outside the US, generic uncertainty is pushing central banks to focus on downside risks to growth, rather than on upside risks to inflation.