US yields are back to their highest levels since early August after Friday’s blockbuster non-farm payrolls report bolstered the likelihood of a “no landing” scenario in the economy. With investors growing more confident in an outlook in which job creation continues, growth remains robust, and inflation moderates more slowly, the Federal Reserve is now seen easing policy at a more gradual pace than expected only a week ago. Two- and ten-year interest rates holding near the 4-percent threshold, North American equity markets are setting up for a negative open, and the dollar is heading toward posting a sixth daily gain, smashing speculative bets on further weakness and marking a remarkable rebound from September’s lows.
Last week’s data was simply incongruent with consensus expectations for a rapid deterioration in US labour markets. First, August’s job openings and labour turnover survey showed job openings rising. Then, the four-week moving average of initial jobless claims fell to its lowest level since late May. And Friday’s non-farm payrolls report topped consensus expectations by more than 100,000 jobs, and the prior two months were revised significantly higher, lifting the three-month average pace of job creation from 116,000 to 186,000. Unemployment edged lower for a second month, outpacing a rise in the participation rate, and wage growth remained elevated at 4 percent in year-over-year terms.
Rate expectations have shifted dramatically. Futures markets are now pricing in 22 basis points in easing for November – meaning that odds on a 50-basis-point rate cut have plunged into negative territory, and investors now see just two moves by year end, down from more than three a week ago. The policy rate implied for December 2025 has shot up from 2.77 percent in mid-September to 3.39 percent this morning, suggesting that investors see the Fed delivering three fewer cuts over the next five quarters.
More volatility is likely. Fed officials including the Atlanta President Raphael Bostic, St. Louis’ Alberto Musalem, and Governor Michelle Bowman will make appearances later today, and most of their counterparts on the rate-setting committee will hit the speaking circuit later in the week, with investors likely to adjust rate expectations in line with their comments. Minutes taken during the central bank’s last meeting, due for release on Wednesday, could show policymakers expressing confidence in economic conditions, putting further upward pressure on yields. The latest jobless claims number on Thursday will provide valuable insight into how Hurricane Helene impacted labour market conditions. September’s consumer price index and purchasing price index reports on Thursday and Friday should see market market participants scrutinising the details for any sign of a demand-driven recovery in underlying price pressures.
Looking beyond the US, the pound’s upward momentum has stalled, and is in danger of reversing. After outperforming all of its major-economy peers against the dollar through the first three quarters of the year, the currency lost its footing last week when Bank of England governor Andrew Bailey said officials could become a “bit more aggressive” and “a bit more activist” in cutting interest rates if inflation continues to moderate. Traders are cutting bullish bets ahead of finance minister Rachel Reeves’ first budget statement on October 30 – which is expected to couple higher taxes and other austerity measures with a rise in borrowing estimates – and gilt yields remain elevated as investors express concerns over the country’s widening fiscal and current account deficit position. We still think the pound is undervalued at these levels, but suspect that gains will be limited for now.
The euro is trading lower after Governing Council member Francois Villeroy de Galhau said the European Central Bank would “quite probably” cut rates at its meeting on the 17th. With headline inflation running below the central bank’s target in September, and market expectations ratcheting lower in line with deteriorating growth and sentiment numbers, policymakers are now seen delivering rate cuts at an accelerated pace through the early new year.
Oil prices are pushing higher, driven by fears of another, more supply-disruptive escalation in the ongoing conflict in the Middle East. President Biden is reportedly putting pressure on Israel to avoid hitting Iranian energy infrastructure in retribution for last week’s missile attack – and we don’t think the strategic calculus supports a strike on the critical Kharg Island export terminal – but tanker traffic has been temporarily rerouted away and the country’s refineries remain within the realm of possibility, meaning that the oil markets are facing an elevated risk of disruption.
The Canadian dollar is holding steady, with higher oil prices and a sympathetic reaction in interest rates after last week’s non-farm payrolls report doing little to alleviate the malaise that has kept rate differentials tilted against the currency for most of the last two years. Developments in the US economy will likely play a dominant role in driving price action through the early part of this week, but that dynamic could change on Friday. With consensus estimates set very low ahead of the September jobs report, an upside surprise could shock the loonie higher, and stubbornness in the inflation expectations component embedded in the Bank of Canada’s business and consumer surveys could have a similar impact on projections for the October policy meeting. Market-implied odds on an outsized 50 basis-point cut are now down to less than 25 percent, and we think they could go lower as spillover effects from the change in the US economic narrative hit home north of the border.
