The market’s reaction to the NFP data coming out tomorrow might be a bit muted after the changes following the Fed’s most recent meeting. Labor figures are important to the markets for two main reasons: Insight into how the economy is going, and implications for Fed policy. There will be two more NFP releases before the Fed meets again, so the impact on monetary policy from tomorrow’s data could be reduced.
On the other hand, the market is on tenterhooks with the recent trouble seen in two more regional banks. The Fed has heavily implied that there will be a rate pause at the next meeting, and now markets have shifted to betting on when the “pivot” will happen. The pivot is generally understood as when the Fed will start cutting rates. And defining those expectations could come down to the labor data, particularly if it comes out very different from expectations.
Setting up the context
The Fed and the markets are at odds about what will happen to interest rates going forward, and that has major implications for the dollar. After the FOMC meeting on Wednesday, the market started pricing in a first rate hike as soon as July, followed by another cut in September. The Fed insists that it will keep rates high through the rest of the year.
If the Fed is right, it means that traders are substantially undervaluing the dollar. Yields have been under pressure in expectation of the rate cuts later in the year, which makes the dollar less valuable compared to other currencies, particularly the Euro. If the Fed manages to stick to its guns, it could mean the dollar trends higher as the market is forced to adjust. On the other hand, the market might not be pricing in enough of a cut. If the Fed does cut, it will be to head off a major recession, and that would require more than just 50bps of cuts. If the market is right, it might still be wrong by the degree of the cuts.
What to look out for
Jobs numbers are a lagging indicator for the economy, since businesses typically will only cut workers after it becomes abundantly clear that there is a drop off in demand. By the time the unemployment rate starts rising, essentially, the recession is already here. So, traders aren’t looking for “advance warning” of a recession in the upcoming data, but signs that employers are throttling back. Job creation has been well above average ever since the end of the pandemic as businesses try to get back to “normal”; and the US is still short around 3M jobs to reach full recovery. NFP below 200K would be an indication of a slackening off of the labor force, implying even slower wage growth, and would be among the things seen as the economy turns over to start heading for a recession.
The consensus among analysts is that there were just 190K jobs created in April, compared to 236K in March. That is expected to contribute to the unemployment rate ticking up to 3.6% compared to 3.5% prior, with steady labor force participation. As far as potential impact on inflation, average wages are expected to increase at the same rate as last month at 3.0%.