U.S. equities rallied sharply at the end of last week as did the dollar, despite the NFP disappointment.
The headline number for the rise in jobs came short of analysts’ expectations, “164K vs. 193K forecast”, but the previous month’s figure was revised up by 32K. Average hourly earnings also came in below expectations, growing by 2.6% YoY. The bright spot was the unemployment rate which dropped to an 18-year low at 3.9%.
Overall the labor market remains solid, and with rising inflation the Federal Reserve will persevere with monetary policy normalization. However, there isn’t enough indication yet of the economy overheating, suggesting that two more rate hikes for 2018 will remain the base case scenario.
With the U.S. earning season coming closer to an end, politics are likely to dominate again. Here’s what to watch for the week ahead.
Decision on China; Nafta talks
The first round of negotiations between China and the U.S. ended on Friday with no breakthrough. Although China said some progress was made in trade talks, there weren’t any tangible results. The U.S. demanded China cut the trade deficit by at least $200 billion by the end of 2020, which to many economists seems a mission impossible. The ongoing negotiations might have bought some time and eased tensions in the short-run, but investors will remain alert for another round of trade threats. Markets will closely scrutinize any statement from President Trump on this front.
The negotiation skills of team Trump will be tested again next week, as Nafta talks resume. According to U.S. Trade Representative, Robert Lighthizer, failure to complete trade negotiations with Canada and Mexico in the next two weeks could put the agreement in jeopardy. The Canadian dollar and Mexican peso would be hit hard if a deal doesn’t come through.
Iran Nuclear deal
With oil trading at its highest levels in more than three years, investors are in “wait-and-see” mode on whether to push prices to new highs or start taking some profit. Over the past few weeks, Trump has been criticizing the Iranian nuclear deal and is set to withdraw from it on 12 May, unless his European allies agree to fix the deal. Although oil prices have benefited from tighter supplies, a lot of risk premium has been priced in due to Trump’s threat. However, it's challenging to know the magnitude of re-imposing sanctions on oil exports from Iran. That’s why analysts’ expectations varied widely on this front. Whether exports will be hit by 100 thousand or 1 million depends on the nature of the new sanctions. How will Europe react? Will sanctions hit banks and businesses dealing with Iran? How will Iran respond? What about the impact on Middle East politics? Until we get answers to these questions, it’s difficult to estimate the impact on Iranian oil exports. However, prices may remain elevated and even reach $80 in the short run.
Bank of England
A couple of weeks ago, it looked certain that the Bank of England would be hiking rates by 25 basis points, during its May policy meeting. This was before a round of disappointing UK economic data and BoE Governor Carney seemingly backtracking once again from his previous tone that the markets should prepare for an interest rate rise. It is now expected that the BoE will look to raise interest rates gradually and is conscious that there are other meetings over the course of 2018 to raise UK interest rates. As a result, the pound plunged by more than 800 pips from its 17 April peak. While a rate hike is off the table for now, forward guidance may lend the GBP some support, especially if new voices were added to Michael Saunders and Ian McCafferty, who voted for a rate hike in the last meeting.