Mixed Nonfarm Payroll Data Keeps Fed Rate Cut Outlook Uncertain
The U.S. nonfarm payroll report released on Friday came with weaker-than-expected growth figures, but the cooling was not too sharp.
Following the 114K payroll growth in July, market participants anticipated a recovery to 165K; however, the data revealed growth of only 142K. This left the three-month average of payroll growth at its lowest level since mid-2020, confirming a cooling in the U.S. labor market.
The report published by the U.S. Bureau of Labor Statistics showed that the initial figures released in June were revised downward by 61K, from 179K to 118K, and the 114K growth in July was revised down by 25K to 89K. This highlighted that the cooling in the labor market had begun earlier than the July report, which caused market turbulence.
On the other hand, the unemployment rate fell in line with market expectations. After surging to 4.3%, the highest level since November 2021 in July, it declined to 4.2%. In August, temporary layoffs decreased by 190K, while no significant change was reported in permanent layoffs.
The U.S. labor market continues to cool, but the payroll numbers were not sharp enough to label this cooling as deterioration. Therefore, this report failed to consolidate expectations about how much the Fed will cut interest rates at next week’s policy meeting.
Following the report, the probability of a 50-basis-point rate cut rose to 59%, while after comments from some Fed officials, the odds shifted in favor of a 25-basis-point cut.
Just minutes after the report, New York Fed President John Williams stated that the risks to the Fed’s two mandates are now better balanced, and policy should be adjusted to reflect this balance. Williams added that the recent figures are consistent with what they have been observing, that the economy is slowing, and the labor market is cooling.
Later, Federal Reserve Governor Christopher Waller also commented that the data showed the labor market continues to soften but has not worsened.
Consequently, Fed officials have reached a consensus that rate cuts should begin at next week's meeting; however, they interpret the cooling in the labor market as normalization and emphasize that they see no evidence of an impending recession. This has shifted expectations for a rate cut towards 25 basis points with a 71% probability, while 29% of participants continue to price in a 50 basis point cut based on labor market conditions.
After the payroll data left expectations regarding the extent of rate cuts uncertain, all eyes are now on the last inflation report to be released this week ahead of the decision.
The Consumer Price Index (CPI) report for August, to be released on Wednesday, is expected to show headline inflation dropping from 2.9% to 2.6% while core inflation remains unchanged at 3.2%.
Markets are debating whether a sharper-than-expected decline in core inflation could persuade the Fed to opt for a 50 basis point cut. However, a figure that meets expectations is unlikely to achieve this.
Gold Retreats Below $2,500 as Fed Rate Cut Expectations Narrow
Aftermarket expectations for the Fed's September rate cuts shifted towards 25 basis points, the drop in U.S. Treasury yields saw a partial rebound. The 2-year yields, which stood at 3.75% before the nonfarm payroll report, pulled back to 3.64% and remained mostly unchanged at 3.68% on the first day of the week. Meanwhile, the 10-year benchmark yields hovered around 3.73%.
Following reduced expectations for a 50 basis point rate cut, GOLD retreated below $2,500 per ounce. The fact that officials are not interpreting the cooling in the U.S. labour market as deterioration reinforces the belief that the Fed will implement rate cuts gradually, which is limiting GOLD’s upward momentum.
On the other hand, according to official data released on Saturday, the People’s Bank of China (PBoC) did not add to its reserves for the fourth consecutive month. The PBoC had been increasing its gold reserves for 18 straight months until April and had significantly contributed to record-high central banks' gold demand since the beginning of the year.
Despite the PBoC suspending its gold purchases, economists predict that central bank purchases will continue to be a driving force in gold demand for the remainder of the year. Additionally, geopolitical tensions and the uncertainty caused by the U.S. elections remain other factors supporting safe-haven demand.
Markets Eye ECB Rate Decision as Inflation Falls Toward Target
This week will be critical for the Eurozone due to the European Central Bank's (ECB) monetary policy decision.
Preliminary readings of the August inflation data revealed that headline inflation in the Eurozone fell to 2.2%, down from the previous increase of 2.6%, while core inflation 2.8%. The sharp decline in headline inflation towards the ECB’s target rate has strengthened expectations for further rate cuts.
At Thursday's meeting, markets expect the ECB to cut interest rates by 25 basis points. This cut would bring the rate on the main refinancing operations down to 4% and the rate on the deposit facility to 3.5%. Given the decline in inflation, monetary policy will remain in restrictive territory despite the rate cut.
Growth data released last Friday showed that the Eurozone grew by 0.2% in the second quarter, missing the initial estimate of 0.3%. While inflation continues to decline in the Eurozone, risks to growth are increasing.
Production activities are sluggish, household consumption is low, and sentiment remains below pre-pandemic levels. Economists warn that if the region's economic weakness persists, it could pull inflation below target, potentially leading to more dramatic monetary easing.
This situation is fueling expectations that the ECB might cut rates also in October, in addition to the two 25 basis point rate cuts already fully priced in for September and December. After Thursday’s decision, market participants will closely watch President Christine Lagarde’s speech for any hints regarding future rate cuts.
China’s Inflation Falls to Weakest Levels in Three Years, Pressuring Growth
Early in the day, China's inflation data revealed that inflation has fallen to its weakest levels in three years. The August consumer price index increased by 0.4% monthly, missing the expected 0.5% rise. On a yearly basis, it rose by 0.6%, surpassing the previous 0.5% increase but falling short of the 0.7% market expectation.
The latest data from China highlights that household spending continues to struggle in the recovery, further pressuring the annual growth target. The Chinese economy is grappling with the longest streak of consumer price declines since 1999. Economists warn that this could trigger a downward price-wage spiral and may require a radical policy response.
So far, the Chinese government has taken various steps to boost domestic consumption, but economists argue that policy needs to become more proactive.