19 May 2016
Fed Hike in June Unclear –
But US dollar Will Strengthen Either Way
The US jobs data released on 6 May, 2016 might be weaker than expected, but our Chief Economist
Megan Greene believes it is no reason to write off chances of a US interest rate hike in June. More
importantly, she points out that the US dollar is likely to strengthen again after the recent pause – a
development that could have deep significance for the financial markets.
Towards the end of this note, Manulife Asset Management’s fixed income teams will discuss their
views and portfolio positioning.
Commenting the US April job report released on 6 May, 2016, Manulife Asset Management’s Chief
Economist Megan Greene thought the number of jobs added, at 160,000, was well below
expectations (around 200,000)1, but this headline figure is one of the least important indicators in
the jobs report. Digging into the details, the news was not all bad.
Megan added, this jobs report will certainly not light a fire under the Federal Reserve’s (Fed) feet to
hike rates at their next meeting in June, nor does it rule June out for a rate hike. Investors are
breathing a sigh of relief that the Fed may wait to tighten monetary policy further, as this has driven
a reversal of US dollar strength in the first four months of the year, stabilizing oil prices and easing
financial conditions in emerging markets (EM).
But they shouldn’t get used to it.
US dollar strength depends just as much on the Fed’s moves as on those of other central banks.
Even if the Fed stays put, we expect significant easing from the Bank of Japan (BoJ) and the
European Central (ECB) to push the dollar up again, reversing the recent trend.
Jobs Report: Something for Everyone
There was something for everyone in the April jobs report. The headline figure was lower than
expected, but more importantly the labor force participation rate fell from 63% to 62.8%. More
people gave up looking for work than found employment. Unemployment remained steady at 5%.
But the news was not all disappointing - the number of people working part-time for economic
reasons fell in April after jumping in March. After plummeting for two months, jobs were actually
added in manufacturing—a high wage industry—last month. Low wage sectors (retail,
administration and waste, social assistance and leisure) comprised around 26% of new jobs in the
private sector— the lowest level in a year. Average hourly earnings growth was slightly stronger in
April at 0.3% month-on-month, but is still nothing to write home about.
1
Bureau of Labor Statistics: Employment Situation Summary, May 6, 2016
19 May 2016
Impact on the Fed
The latest Non-Farm Payroll (NFP) report had enough negative and positive indicators to have little
impact on the Fed’s likely actions in June. Combined with incredibly weak first quarter GDP data
and a potentially close Brexit referendum in the UK one week after the June Federal Open Market
Committee (FOMC) meeting, this NFP report could suggest the Fed will stay on hold next month.
But given that growth should accelerate slightly in the second quarter, and we will have a lot more
US economic data as well as Brexit opinion poll results by June, a Fed rate hike at the next meeting
is not entirely off the table.
Ever Weaker US dollar?
A June rate hike is not at all priced in at this point, so unless the Fed starts signposting a rate hike
more clearly the markets will be caught out and we would expect the US dollar to strengthen. If the
Fed remains on hold in June, however, do not assume that US dollar weakness will continue for the
rest of the year.
In trying to gauge what will happen with the US dollar, a lot of analysts have looked to the Fed. After
all, dollar weakness this year was largely driven by the Fed’s revision of its own forecasts from four
rate hikes for 2016 at the beginning of the year to only two rate hikes 2. This is only half of the
equation though. It is just as important to look at other currencies—starting with the renminbi.
The renminbi is down slightly against the US dollar, but is significantly down versus a basket of
currencies (including the euro and the yen) since the beginning of the year. In addition to suffering
from an appreciation of their currencies relative to the US dollar, Japan and the eurozone are
suffering from an appreciation relative to the renminbi as well. This will provide a headwind for
2
Federal Reserve: Economic Projections, March 16, 2016
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19 May 2016
growth that Japan and the Eurozone can hardly afford given their already lackluster growth
prospects (we expect growth of 1% at best in Japan and 1.5% in the eurozone this year).
Furthermore, inflation expectations in Japan and the eurozone remain well below the BoJ and
ECB’s target of 2% (close to but below 2% for the ECB) despite both central banks recently
announcing a raft of easing measures.
Inflation Expectations in Japan and the eurozone Remain Below Target
It is therefore a question of when and how, not if, the BoJ and ECB will significantly ease further.
The BoJ may follow in the ECB’s footsteps and announce a TLTRO-like program3 to pay banks to
lend. We expect that, like in Europe, this could help along the margins but is hardly a silver bullet.
The BoJ and the ECB are likely to also try doing more of the same: cutting rates further into
negative territory and expanding and extending their quantitative easing programs.
The verdict on negative rates is mixed at best, and negative rates bite into bank profits, which is of
particular concern in parts of the eurozone where some bank balance sheets leave a lot to be
desired. More quantitative easing could have an impact on inflation expectations if the basket of
purchased assets is expanded to include equities. There is likely to be more resistance to this in the
eurozone than in Japan, but we expect both central banks will eventually have to implement this
measure.
If the Fed hikes rates in June, we expect the US dollar to strengthen given that markets are only
pricing in one Fed hike in 2016. If the Fed is more dovish and waits to hike, this will put even more
pressure on the BoJ and ECB to ease aggressively, which in turn will push the US dollar up.
Investors should therefore not get too comfortable with the recent market rally we have been
enjoying, as a stronger US dollar will have negative implications for oil and for financial conditions in
EM. The volatility we experienced at the beginning of the year may feel like a distant memory, but
we are likely to be reminded of what it felt like later this year.
3
European Central Bank: ECB announces new series of Targeted Longer-Term Refinancing Operations (TLTRO II), 10 March, 2016
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19 May 2016
Our fixed income positioning
Looking ahead, Asian fixed income investors should not be over complacent as some Asian
economies are showing signs of slowing down, said Endre Pedersen, Chief Investment Officer,
Fixed Income, Asia ex-Japan of Manulife Asset Management. Endre and his team believe that it is
not an environment for investors to take aggressive positions, but rather an opportunity to
consolidate gains while actively managing risks.
Endre added, “We remain biased towards holding US dollar against Asian currencies. While our
view on Asian currencies remains defensive, we have a preference for South Asia over North Asia
currencies. We are more cautious on Asian currencies following the broad strong Asian currency
performance, and so the portfolio has a more defensive currency positioning with a bias towards US
dollar denominated Asian bonds."
In addition, Manulife Asset Management’s Global Multi-Sector Fixed Income Team believes that
growth differentials, diverging central bank policies, and structural positives will continue to be
supportive for the US dollar, but given the large move over the past 18 to 24 months, Global MultiSector Fixed Income Team would expect further appreciation of the dollar to be at a slower pace
and of a smaller magnitude, and continue to hedge the majority of the portfolio back to the US
dollar.
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