Fed Rate Hike Expectations Sensitive to Jobs Data

The stability of the US dollar after a tumultuous Friday session reflects a complex interplay of economic indicators.

Initially spurred by a robust non-farm payrolls report, the currency’s gains were short-lived, eroded by a weaker-than-expected ISM services survey later in the day. This economic rollercoaster prompts a closer examination of the nuanced factors influencing the dollar’s trajectory and their broader implications.

In the aftermath of the non-farm payrolls release on Friday, the US dollar embarked on a notable uptrend. The report revealed a commendable addition of 216k jobs to the economy in December. However, the initial optimism was tempered by downward revisions, amounting to -71k in prior months’ job gains. Stripping out government sector jobs, a more comprehensive picture emerged, indicating a persisting slowdown in private sector job growth. The average monthly increase in private payrolls stood at 134k in the second half of the previous year, a notable decline from the 204k/month in the first half.

Delving deeper into the labour market dynamics, a discernible deceleration in employment growth becomes even more pronounced when considering more cyclically sensitive sectors. Excluding government, healthcare, and education, the average monthly increase dwindled to a mere 40k in the latter part of the previous year compared to a robust 122k/month in the first half. These figures underscore a broader trend of weakening labour demand, raising concerns about the alignment with labour supply and its implications for inflation.

Despite the seemingly positive employment figures for December, underlying trends suggest a nuanced reality. While the Federal Reserve may find reassurance in the immediate data, a closer look reveals a more intricate narrative. Private sector job growth slowdown, coupled with the decline in more sensitive sectors, suggests a weakening labour market, potentially aligning with supply dynamics. This alignment could serve as a mitigating factor against inflationary pressures, providing the Fed with a nuanced perspective on the overall health of the economy.

The household survey, however, introduces a contrasting narrative, adding layers of complexity to the analysis. The participation rate witnessed a significant 0.3ppt drop to 62.5%, accompanied by a substantial decline of -676k in the labour force and -683k in employment. Notably, this marked the largest monthly drop since the onset of the COVID shock in early 2020. While caution is advised regarding the volatility inherent in the household survey, these substantial shifts in employment and the labour force demand attention.

Average hourly earnings growth, a crucial metric indicating wage pressures, increased by 0.4% M/M for the second consecutive month. This persistent growth highlights ongoing concerns for the Federal Reserve regarding upside inflation risks stemming from a tight labour market. The confluence of factors suggests a delicate balancing act for the Fed, navigating between ensuring robust economic growth and containing inflationary pressures.

While the employment report alone may not suffice to trigger an immediate response from the Federal Reserve, it has left an indelible mark on market expectations. The initial strengthening of the US dollar, driven by reduced expectations of a rate cut, was short-lived. The ISM services survey for December delivered another warning signal regarding the strength of labour demand, leading to a swift reversal of gains. The employment sub-component dropped sharply by 7.4 points to 43.3, marking the largest decline since the 1H of 2020 during the COVID shock.

Examining historical context, such a substantial drop in the employment sub-component has occurred only three times since 1998, notably during periods of economic recession. This abrupt adjustment challenges the prevailing market expectations for a soft landing for the US economy. While the inclination may be to attribute it to a one-off reading exaggerating weakness, recent declines in other labour market indicators, such as the JOLTS hiring rate, suggest a more pronounced slowdown in labour demand may be underway.

The economic landscape, as painted by these multifaceted indicators, underscores the complexity facing policymakers and market participants. The delicate balance between a seemingly robust employment report, underlying trends indicating a slowdown, and cautionary signals from the ISM services survey requires nuanced interpretation. As the market adjusts its expectations and the Federal Reserve navigates these intricate dynamics, the coming months will likely witness heightened scrutiny of labour market data, shaping the narrative of the US economic outlook.

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