As all eyes are focused on the Non-Farm Payrolls (NFP) report to be released on Friday, market participants are increasing their bets that the Federal Reserve (Fed) will begin cutting interest rates at a pace aimed at countering a potential recession.
Last month’s labor market data showed that the unemployment rate reached a three-year high, while payroll growth slowed to its weakest pace since the pandemic. These figures have fueled concerns that the Fed waited too long to ease interest rates and that the economy is now heading toward a recession.
Although these concerns have eased since then, both the markets and the Fed have shifted their focus largely to developments in the labor market. In his Jackson Hole speech last week, Fed Chair Jerome Powell gave the clearest signal yet that the Fed’s focus has shifted from inflation to the labor market. Additionally, the markets interpreted Powell’s omission of the word “gradual” in his speech as leaving the door open for more aggressive rate cuts.
On the other hand, last week’s strong growth and inflation data from the U.S. slightly tempered expectations that the Fed would cut rates swiftly. However, recent data showing continued contraction in the manufacturing sector has reignited recession fears. Consequently, the upcoming critical labor market data, which will shed light on the state of the labor market ahead of the next FOMC meeting, could clarify the direction of recession concerns.
Market participants continue to price in 100 basis points in rate cuts from the Fed this year, with expectations of over 200 basis points in cuts by July of next year.
Following this week’s data, expectations for a 50 basis point rate cut in September have risen to 45%. Therefore, a weaker-than-expected August payroll report could easily shift the base case toward a 50 basis point cut. Otherwise, we might see expectations for rate cuts by year-end easing to around 75 basis points.
Crucial Labor Data: Recovery or Deterioration?
This first report following the surprisingly low July figures is crucial in determining whether the previous data represented a temporary dip or the start of a deterioration in the labor market.
Economists' forecasts for payroll growth range between 100K and 208K, with the median estimate suggesting an increase of 165K in August.
If the data meets expectations, it would indicate a significant recovery compared to July but still fall below the 3, 6, and 12-month averages of 170K, 196K, and 209K, respectively. However, such a result is likely to be interpreted as normalizing the labor market rather than the beginning of a deterioration.
Was the July Payroll Report Influenced by Temporary Factors?
According to a report released by the U.S. Bureau of Labor Statistics (BLS) in August, the number of unemployed individuals on temporary layoff increased by 249K in July. This marks the largest rise since late 2020 during the pandemic period.
The increase in temporary layoffs is believed to be due to the impact of Hurricane Beryl, which made landfall in July. It is estimated that this could have reduced the non-farm payroll growth figures by around 20 to 30 thousand.
Additionally, the BLS report shows that the number of unemployed individuals increased by 352K in July, pushing the unemployment rate to 4.3%. While the number of people unemployed due to temporary layoffs significantly increased, permanent layoffs saw very little change throughout the month.
As a result, this report supports the notion that the July figures were affected by temporary factors, aligning with expectations of a recovery in non-farm payrolls and a drop in the unemployment rate to 4.2%.
Jobless Claims Decline, Reinforcing Temporary Factor Theories for July
While the monthly reports are the primary data tracked for the labor market’s condition, the weekly Initial Jobless Claims figures can provide valuable insights as leading indicators.
When comparing the number of unemployment benefit claims in June and July, there is an average increase of only 2,000. This supports the belief that the rise in the July unemployment rate and the decline in payroll figures were driven by temporary factors.
U.S. Employers Reduce Job Openings, Layoffs Stable in July
Yesterday, the Bureau of Labor Statistics (BLS) released the July Job Openings report, showing that job vacancies fell to 7.67M from the previous 7.91M, coming in below the market expectations of 8.1M. This data indicates that the number of job openings has dropped by 1.1M annually.
The report also revealed that hiring remained relatively unchanged at 5.5M for the month, while total separations slightly increased to 5.4 M. Within separations, quits accounted for 3.3M, which is 338K lower than the same period last year. Layoffs and discharges, however, saw little change at 1.8 M.
In summary, this report indicates that U.S. employers are slowing down new hiring, but there hasn’t been a significant change in layoffs.
Conclusion
In conclusion, while markets are prepared for a potential negative scenario regarding the payroll report, factors suggesting that the previous report was influenced by temporary elements are keeping participants on alert.
Although the Fed’s focus has shifted from inflation to labor market risks, it may be difficult for the Fed to be convinced of a 50 basis point aggressive rate cut at the upcoming meeting if payroll growth does not show a downside surprise as it did in the previous month.
The private sector Employment Change data to be released today will be closely watched, as it may provide important insights ahead of tomorrow’s critical report. Additionally, the release of the Purchasing Managers' Indexes will offer further clues about economic activity.