Volatile week possible after inconclusive US labour market data

We struggle to recall a more eagerly awaited US labour market report than that published on Friday. Stakes were high given the previous report showed a steep rise in unemployment and caused market mayhem in early August, but anyone hoping for a conclusive picture was left disappointed as a mixed set of figures left the strength of the US economy open to interpretation.

For the bulls, first and foremost there was the unemployment rate, which at 4.2% came bang in line with expectations and confirmed that the previous month’s spike to 4.3% was not the start of a runaway rise in unemployment, at least for now. The participation rate also held steady at 62.7%. Manufacturing job creation was weak, which is not surprising given the sector has struggled not only in the US but around the world, while in the services sector things looked brighter. Temporary layoffs were shown to be partly responsible for July’s poor numbers, which seem to have reversed. If you wanted to be a real monetary policy hawk, you could point to average hourly earnings at 0.4% month-on-month showing their strongest growth since January this year. It would be a rare event to have wages accelerating in a recession, or close to one. Average weekly hours also increased mildly, which again is not something you would typically see in a recessionary environment.

For the bears, there was also plenty of ammunition. The change in non-farm payrolls was lower than expected at 142k, while revisions to previous months were very clearly negative; July’s figure was revised down from an already weak 114k to 89k. The trend is unambiguously clear that the labour market is cooling off and there is a risk that the trend becomes more difficult to stop if the Federal Reserve (Fed) does not act promptly and cut rates. In fact, the Fed chair Jerome Powell himself has said that further deterioration in labour markets would be “unwelcome”.

In our view the report leaves the door open for a 50bp cut on September 18, even if the most likely scenario remains a 25bp move. Perhaps more importantly for medium term investors, the chances of a sharp reversion of the recent rally in rates are slimmer. We had confirmation that the labour market is not falling off a cliff, but at the same time the slowdown is marked enough. If the Fed does cut by 25bp, we would expect the rhetoric of Powell’s statement and press conference to be dovish. This means that the very short end of the US Treasury curve might react negatively as current levels are pricing in more than 25bp for September’s meeting. But if the Fed sounds somehow worried and the tone is firmly on the dovish side, we doubt the long end of the curve would move dramatically higher. In the meantime, spreads went marginally wider at the index level, with not much change in cash prices.

We expect a reasonable amount of volatility in the next week as Fed officials’ words will be scrutinised to the last comma by market participants looking for an answer on how large the rate cut will be, though investors should keep in mind this data-dependent Fed is essentially looking at the same inconclusive data as we are.