Beige Book paints bleak US economic picture, markets eye payrolls
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The U.S. economy faces tariff risks and sluggish activity, with upcoming jobs data poised to influence global markets.
The U.S. economy is showing signs of strain, with tariff risks and flat activity dominating recent economic assessments. This week’s market focus sharpens on crucial U.S. payroll data, which could significantly sway global financial sentiment. In the eurozone, robust jobs figures could bolster market confidence, potentially lifting longer-term interest rates, though shorter-term rates face higher hurdles to move.
That Beige Book Is Bleak
The Federal Reserve’s latest Beige Book report paints a decidedly bleak picture of the U.S. economy. For coffee aficionados, a detail from the New York survey highlights the pervasive impact of tariffs:
“A coffee roaster reported that tariffs on Brazilian coffee and on other supplies were creating shockwaves through the supply chain.”
The report repeatedly flagged tariff-related price increases. Even businesses not directly importing faced ripple effects:
“A printer manufacturer that doesn’t import products experienced increased costs ranging from 5% to 15% from suppliers who were subject to tariffs.”
The report also noted strains on household budgets, a contraction in job market opportunities, and stagnant to declining consumer spending. It represents one of the more somber assessments from the Fed in recent memory.
Treasury markets showed muted reactions to the Beige Book, partly due to prior price adjustments following earlier economic weakness indicators. The yield curve flattened, with longer-term yields falling more than short-term ones. The benchmark 10-year Treasury yield dipped but found support around 4.2%, while the 2-year Treasury yield bounced off the 3.6% level.
The U.S. dollar also weakened significantly, falling below 4.9%. This move was partly driven by easing upward pressure on longer-term yields, aided by a decline in swap rates. However, upward pressure on the U.S. dollar persisted, particularly when swapped back to euros, where synthetic yields exceeded 7%.
Despite the recent flattening in U.S. yields, the prevailing view suggests that yields are likely to steepen from both ends of the curve.
Big US Job Data Surprises Needed to Change Direction of Euro Rates
While U.S. interest rate movements have had a diminishing impact on eurozone rates, this correlation could re-emerge if the U.S. jobs market weakens. Positive economic surprises in the eurozone have boosted sentiment, leading to a rise in 10-year swap rates, diverging from U.S. trends. Smaller, less negative surprises in U.S. jobs data would likely have minimal impact on eurozone rates, allowing 10-year swap rates to climb further. However, significant negative surprises would dampen global risk sentiment, likely causing a decline in 10-year eurozone rates.
A more pronounced downturn in the U.S. economic outlook would be necessary to drive down front-end euro curve rates. Current dynamics suggest spillover effects are concentrated on the long end of the curve, extending to 30-year rates. Rates up to 2 years are largely anchored by market expectations that the European Central Bank will reduce its policy rate to between 1.75% and 2%.
Recent shifts in interest rate expectations have had little effect on this outlook. However, a resurgence of recession fears in the U.S., coupled with disappointing payroll figures, could push markets towards anticipating a more dovish stance from the European Central Bank.
Thursday’s Events and Market View
Economic data releases for Thursday include eurozone July retail sales. Additionally, markets will monitor ECB’s Cipollone’s address to the European Parliament. Nevertheless, the primary focus remains on U.S. labor market indicators. Payrolls are anticipated to show modest growth of 65,000. Unemployment claims are forecast to rise to 89,000 in August from 62,000, with weekly jobless claims expected to hold steady. The Purchasing Managers’ Index is projected to move further above 50, while Fed President Williams is scheduled to discuss the economic outlook.
In the primary market, Spain plans to auction up to €6.25 billion in bonds. France will also issue a new 10-year benchmark bond alongside two longer-dated issues, aiming to raise a total of up to €11 billion.
