US Non-farm Payrolls (NFP): The next test for US yields and the dollar
Summary: The US economy may be in an economic slowdown, but it is not crashing. The lack of forward guidance from the Fed has meant that every data point and every Fed commentary will be scrutinized to its best extent in order to get more light on the future path of Fed rates. The jobs report from the US due this Friday will likely be a key input, given that a tight labor market remains one of the key pillars of strength for the US economy. Particularly, wage growth remains on watch as it holds the potential to reverse the weakness of the US dollar if US Treasury yields rise.
What are the non-farm payrolls?
The non-farm payrolls is one of the most closely-watched monthly indicators released by the US Department of Labor, usually on the first Friday of every month. The release includes the number of people currently in employment as well as the unemployment rate and wage growth in the US. While it is always important to watch this data for a better understanding of the dynamics of the US labor market, it has garnered increasing attention lately given it is the key pillar of strength in the US economy amid increasing pessimism on the growth front and the lack of forward guidance from the Fed.
Expectations from July NFP and what it could mean for the Fed policy?
There is no denying that the US labor market is slowing, but that is to be expected after a post-pandemic surge. There are still two vacancies for every unemployed American, and small businesses are facing heavy staff shortages. This means the problem is still more on the supply side of labor, rather than the demand side, suggesting that the economy is still in a position to absorb further Fed tightening.
The recent surge in weekly jobless claims points has hinted that the tight labor market may be loosening, but the 4-week average for claims, which smooths weekly volatility, was still at sub-300k levels in the week ended July 23. The ISM reports also suggested that even if the US economy is slowing, it is not collapsing. The ISM factory employment index ticked higher to 49.9 in July from 47.3 previously, pressured mainly due to the lack of workers available. This potentially raises the possibility of a better-than-expected NFP print as well on Friday. Bloomberg consensus is suggesting gains of 250k in nonfarm payrolls and 228k in private payrolls, with unemployment rate steady at 3.6% and average hourly earnings slowing slightly to 4.9% y/y from 5.1% previously.
Meanwhile, sustained growth in wages also supports the case for high-for-longer inflation. Higher salaries mean more money in American consumers’ pockets, and that could possibly mean sustained demand levels – again providing room to Fed to stay hawkish.
The other key thing to note from the NFP data would be the composition of the labor market, especially to understand if the gains in payrolls will be durable. Labor market growth is currently concentrated in the leisure and hospitality business, which remains exposed to a cyclical slowdown in discretionary spending. Hiring in the construction sector is likely to be slower due to the higher mortgage rates impeding housing sector growth.
Markets are mispricing Fed expectations
What Powell’s lack of forward guidance from the July meeting has meant is that the markets are now pricing in peak Fed hawkishness. The terminal rate is now priced in at 3.25% and markets expect the Fed to cut rates next year. We believe that the path of Fed rate hikes from here is likely to be more volatile, and there is some scope for upward repricing. Friday’s NFP data could be one of the triggers.
A stronger-than-expected outcome on both the headline jobs number and wages could raise the expectations of another 75bps rate hike in September, although we still have a lot more data and Fed speakers on tap before we get closer to that meeting. That should bring the US yields back higher and provide a boost to the US dollar. A high wage growth, even with a modest headline number, could still mean the Fed could stay focused on the inflation problem, given that the lower number of jobs only means that the tight labor market is loosening. However, if wage growth is slower-than-expected, it could further dent rate hike expectations and provide more legs to the weakening dollar momentum.
There is some possibility that the USD could surge even if yields are lower and US data is weak if the market forecasts for a soft landing transition to one for a harder landing and that ignites safe haven flows into the dollar. The US dollar has recently been more correlated with financial conditions and direction in US yields, but if yields are lower while market fear levels pick up the USD might prove strong against pro-cyclical currencies.
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