The FOMC will hold its September meeting next week, and the market is still not sure what it will do. Friday’s blowout jobs report came as a major surprise to markets, but expectations around the Fed did not vary much, suggesting traders are waiting for the CPI numbers to make a decision. That means Friday’s data could be the biggest market event ahead of the Fed meeting.
While financial media headlines have focused on the situation in the Middle East, the impact on the market seems to be in the short-term. For fundamental factors, traders appear to be discounting fluctuations in the conflict and focusing on the medium term and how the Fed will react. While monetary policy will primarily affect the dollar and gold, the yen is also notably in play as Japanese investors could repatriate depending on the Fed outlook.
Why the Market Is Unsure About the Fed
The uncertainty about the Fed’s outlook can be measured by the odds, with over 60% of a rate hike priced in. The issue at stake is whether higher headline inflation is actually being passed through to the economy, known as “second-round” effects. Unlike in Europe, where the ECB is hiking rates as the shared economy has to import almost all of its petroleum products, the US is a major producer and exporter of crude oil. This makes the pricing dynamic different.
Economists predicted a fairly fast and dramatic pass-through in energy costs, and that has partially happened. Prices at the pump jumped, annoying many Americans about another war in the Middle East. However, there have been no signs of major price shifts across industrial goods and infrastructure so far. As the US economy shows signs of slowing, the Fed could hold off on further rate hikes unless there is a clear signal that core inflation is accelerating.
Why NFP Failed to Shake the Market
Friday’s Non-Farm Payrolls more than tripled expectations, while the unemployment rate held steady at 4.1%. This largely aligns with the Fed’s view that the job market is “stable”. Crucially, the wage growth rate fell to 3.1%, the lowest in years, and is also in line with a slow-hiring, slow-firing market that typically does not cause inflationary pressure.
If wages aren’t rising, then consumers don’t have additional money to buy more goods, and average hourly earnings have fallen below the inflation rate. This is often a sign that inflation will also turn lower. Meaning that even though there was a beat in the total number of people finding work, the macro background remained stable, if now slightly pressuring inflation downward. To reverse this effect, there would have to be a substantial beat in the CPI number for the odds of a rate hike to increase.
What the Market is Looking For
The US August annualised inflation rate is projected to stay unchanged at 3.4%, while the core rate is anticipated to tick down to 2.4% from 2.5%. The difference between the two readings is generally attributed to energy costs. But if core inflation is declining, it would be a sign that the feared second-round effects of the war in the Middle East are not materialising.
A substantial miss in core inflation would likely raise the odds that the Fed will punt at next week’s meeting, and weigh on the dollar. By contrast, a rise in the inflation rate excluding energy could lead the market to fully price in a rate hike, boosting the dollar in the process. Gold would likely move in opposition to the dollar.
