Global Daily – A walk on the supply side

by: Nick Kounis , Georgette Boele

140117-Global-Daily-Insight.pdf ()
  • There is growing evidence of supply side constraints in the US labour market…
  • …while not an immediate issue for the Fed, they could lead to earlier hikes in 2015 than its signalling
  • Eurozone excess liquidity falls yet further, adding to case for ECB action
  • Gold prices are likely to resume their downward trend

Reports of US wage pressures fit well with evidence of supply side constraints

The Fed’s Beige Book reported ‘upward movements in wages’ in eight out of the twelve Federal Reserve districts it covers. Although these increases were still described as ‘small to moderate’ it represents a marked difference from previous reports where few if any were reported. The tentative signs of wage pressures are consistent with evidence of supply-side constraints in the labour market. For instance, the participation rate has continued to fall, casting doubt on the Fed’s view that this is largely a cyclical phenomenon. In addition, the JOLTS survey points to an unusually big gap between job openings and hiring (see chart), that might be evidence of a mismatch between the skills employers need and what is on offer. The rise in wages may well be welcomed by the Fed in the near term, as it will add impetus to the economic recovery. However, over time, signs that the labour market has less spare capacity than previously thought could pressure the Fed to raise rates earlier than it is now signalling. This fits in with our view that the first Fed rate hike will come in the middle of next year, rather than late in the year. The latter is the Fed’s current guidance and also in line with what is priced in by financial markets according to interbank rate futures.

Eurozone liquidity surplus falls to EUR 131 bn

Excess liquidity in the eurozone money markets has continued to decline. On Thursday, excess liquidity fell EUR 131bn, compared to EUR 154bn the day before. According to an ECB study, money market rates should remain close to the deposit rate as long as excess liquidity is above a certain threshold, estimated in the EUR100-200bn range (though the ECB also underlines that this relationship is not stable). Indeed, there are already upward pressures on interbank rates materialising, with the EONIA jumping to 0.21% yesterday. For much of last year it trended at below 0.1%. ECB President Draghi announced at the press conference last week that the central bank would act if there was an unwarranted tightened in money markets. Clearly we are now starting to move in this territory. As noted here yesterday, the simplest option would be the official and permanent stopping of the sterilisation of the SMP, though policy rate cuts are also a possibility.


Gold price support from inflation set to fade

Gold prices have had a good start to the year. There are usually several reasons why an investor would buy gold: 1) inflation fears 2) market and/or (geo) political uncertainty 3) low or negative real yields 4) anticipated strong demand for jewellery 5) expectations of capital gains 6) a lower USD. Since the start of December, inflation expectations – as derived from the US Treasury market – have increased. Higher inflation expectations have been supportive for gold prices. Developments in US real yields have also been favourable. Since the start of this year, the rise in 5-Y US real yields has come to a halt, while real yields even edged lower after the US employment report. Going forward we expect inflation to remain subdued, while US real yields are likely to move higher as the economy gains strength and Fed rate hike expectations are built into the Treasury curve. In addition, we see an environment of positive investor sentiment and relatively low market and/or (geo)political uncertainty. Moreover, we expect the USD to rally and the prospect of gold capital gains to be further adjusted downwards. Finally, gold jewellery demand from India is likely to be weak. Though demand from China is set to grow, it will not do so strongly enough to compensate for the weak demand from India. Overall, we expect the gold price to fall to 1000 by the end of the year.