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US December NFP: Cooling the Fed?

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Markets are pricing in an expectation that the upcoming jobs report in the US will maintain the trend favoring the Fed easing up sooner than later. The labor market is expected to keep cooling, but not so fast as to signal a major threat of recession. The question now is if and what kind of a surprise there could be to shake up the markets.

Through the week so far we’ve gotten data that generally conforms to the trend. ISM Manufacturing, for example, was slightly above expectations and improved over the prior month. But, it was still in contraction. The latest JOLTS report from the Bureau of Labor Statistics left things generally unchanged.

The Fed is Still Worried

The issue for the Fed right now is how to bring the last bit of inflation back to target. This is a lot more complicated than bringing inflation down from decade highs. One of the complicating factors is the pressure exerted by rising wages. After months in which workers saw their wages eroding due to inflation, the situation has finally reversed. While that might provide relief to consumers, it can keep up pressure on inflation.

For the last few months, average wages have exceeded the inflation rate. This has led several FOMC members to fret over “tightness” in the labor market, as the number of open jobs far exceeded the number of people looking for work. But that has largely stabilized by the end of last year, with the ratio of openings to seekers returning to around pre-pandemic levels.

Drilling into the Data

One of the ways to measure the tightness of the labor sector is to keep track of the number of people quitting jobs. Generally, people give up work when they think they can find a better job, so the number increases during labor shortages. While the ratio of quits was relatively stable in the last JOLTS report, it tracked with a generalized drop in hiring. That would imply that the level of “tightness” in the market has remained confident, but the dynamism continues to fall.

As far as that could affect monetary policy, it implies that the economy is slowing down, even as the Fed has moved to keep rates steady. That works in favor of the Fed’s view of a “soft landing”, and could mean that rates stay high for longer than the market anticipates as the Fed waits for average earnings to dip below the inflation rate and the unemployment rate to move above structural level.

What’s Important in the Data

The US is expected to have created 150K net jobs last month, down from the 199K reported in November. Meanwhile, the unemployment rate is expected to pop up to 3.9% from 3.7% despite the participation rate remaining steady. This could be a sign of the slowing dynamism in the labor market as people looking for work have to wait longer to find a position they find acceptable.

What could end up being the key to the market reaction is the average hourly earnings, as traders try to anticipate the Fed’s reaction to inflation pressures. This indicator is expected to remain unchanged at 4.0% annual growth. An important drop could raise bets that the Fed will ease up on the tightening sooner. But if rising unemployment doesn’t translate into slower average wages, then investors might give up on the expectations of more rate cuts this year.

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