By :David Scutt, Market Analyst
- Private sector hiring is slowing fast while layoffs are picking up
- Without a decline in participation, that points to upside risks for US unemployment
- The Fed is trying to avoid further deterioration in the labour market
- Markets are split between the Fed delivering a 25 or 50bps cut later this month
- With policy already very restrictive, a spike in unemployment could see the Fed go properly big
Private sector hiring in the United States has slowed to levels not seen since the early stages of the pandemic. Layoffs have surged to five-month highs. If US labour market participation remains steady or increases, the combination points to the risk that unemployment may increase sharply in the August jobs report.
It’s exactly the type of outcome the Fed is trying to avoid, as detailed by chair Jerome Powell during his speech at Jackson Hole. If it eventuates, perhaps the question shouldn’t be whether the Fed will cut by 25 or 50 basis points in September but even harder to get policy rates back towards stimulatory levels?
This looks like prior economic cycles
Markets were taken aback when US unemployment surged 0.2 percentage points in July to 4.3%, mirroring the type of increase seen in prior cycles as the economy falls into recession. With underultilisation jumping 0.4 percentage points to 7.8%, signaling more American workers are unable to find the amount of hours they wish to work, it came as no surprise that risk assets took a bath.
One month on, the stakes for the August jobs report are therefore incredibly high. While the initial market focus will be on the payrolls figure, it really comes down to what happens with the unemployment rate as that’s what the Fed is watching. Markets expect a partial reversal of the July surge, taking the rate back to 4.2%. However, early signals suggest such an outcome may be difficult to achieve without some help from declining labour force participation.
Hiring slows, layoffs accelerate
For a start, private sector payrolls growth, as measured by the ADP National employment report, printed at just 99,000 in August, well below the 145,000 level expected and the weakest pace of hiring since January 2021.
While this survey has been notoriously noisy when it comes to generating investor signals, it must be acknowledged that it’s not been the that different to private payrolls growth reported in the official BLS report. Ominously, in three of the past four months, ADP has overstated the BLS private payrolls figure, warning that we may see something far weaker than the 139,000 figure expected later today.
Source: Refinitiv
And as private sector hiring has slowed, layoffs are increasing with recruitment firm Challenger reporting jobs losses rose to five-month highs in August, tripling the total seen in July. While slightly lower than the same month a year ago, these job losses are occurring at a time when hiring is considerably slower.
Combined, it suggests that rather than decline in August, the US unemployment rate could keep rising, amplifying the risk the Fed will have to cut aggressively in an attempt to limit further weakening in the labor market.
Click the website link below to get our Guide to central banks and interest rates in H2 2024.
https://www.cityindex.com/en-au/market-outlooks-2024/h2-central-banks-outlook/
Markets eyeing a 25 or 50 from the Fed to kick things off
Going into the Fed’s September FOMC meeting, markets have 35 basis points of cuts priced, essentially signalling a near even split between those expecting a 25 or 50 basis point move to begin the easing cycle. But what happens if we see another big increase in unemployment, as was the case in July?
According to the Fed’s own median estimate, a Fed funds rate of 2.8% is deemed to be the level where unemployment would likely stablise, well above the 5.25-5.5% range where it currently resides.
While markets have over 200 basis points worth of cuts priced over the next eight FOMC meetings, even easing of that magnitude would still leave the funds rate in restrictive territory.
It’s why markets and traders may need to be prepared for something even bigger than a 50 from the Fed.
Yes, it would be an admission that it’s once again behind the curve, as was the case when it failed to respond in a timely manner to the surge in inflationary pressures several years ago, but would we be the point of trying to save face by moving slower if it meant allowing unemployment to really surge? If the evidence is compelling, it should act to meet its mandate.
Thinking about the unthinkable
In a scenario where the Fed is forced to cut aggressively, it’s likely the US dollar would weaken against the Japanese yen, Swiss franc and euro, but strengthen against emerging market and cyclical currencies, especially if accompanied by the volatility in risker asset classes.
On the daily chart, the US dollar index (DXY) continues in a bear trend, carving out lower low after lower low since July. Under a scenario where markets swing to the risk of a 50-basis point cut or more from the Fed in September, look for a potential move down to 100.52, the lows struck in July. If that gives way, 99.60 would be the next level of note for bears.
If the data shows resilience, pushing market pricing towards a 25-pointer from the Fed later this month, a retest of former uptrend support could be on the cards.
– Written by David Scutt
Follow David on Twitter @scutty
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