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Markets leap higher on weakening payrolls growth

Goldilocks is enjoying her just-right porridge this morning after a US payrolls report pointed to a gradual easing in labour market conditions, supporting expectations for an imminent end to the Federal Reserve’s tightening cycle.

North America

The US economy added 187,000 new non-farm jobs last month, marking the third consecutive month of gains below 200,000, and helping bolster bets on an imminent end to the Federal Reserve’s tightening cycle. According to the Bureau of Labor Statistics, the unemployment rate jumped off historic lows to 3.8 percent in August, up from 3.5 percent in the previous month’s print (but we note that the increase looks largely down to people entering the job market, not a rise in overall job losses). Average hourly earnings climbed 0.2 percent month-on-month and 4.3 percent on an annual basis, modestly slower than the pace set in July – and the slowest growth since February last year – but still well above levels widely believed consistent with fulfilling the central bank’s inflation mandate.

Data earlier in the week suggested labour market conditions might be easing, with job postings falling by more than expected – although yesterday’s personal spending and income numbers pointed to still-robust underlying demand.

Bad news is translating into good news for markets once again, with equity bourses jumping and Treasury yields slipping as terminal rate expectations are ratcheted lower. Odds on a hike at the Fed’s November meeting are back below the 50-percent mark, and rate cut probabilities are rising beyond the middle of 2024.

Still ahead today: at 9:45, the Cleveland Fed’s Loretta Mester is scheduled to discuss inflation, and S&P Global will update its initial manufacturing sentiment index for August. At 10:00, the Institute for Supply Management should report a modest improvement in its manufacturing index, and this afternoon, Baker Hughes will provide insight into the price response from North American oil drillers. Next week’s holiday-shortened week should be much quieter from a US data perspective, with only second-tier releases on the calendar.

Canada’s economy unexpectedly shrank at -0.2 percent in June, and is expected to flatline in July. This morning’s update from Statistics Canada showed growth tracking well below the Bank of Canada’s 1.5-percent forecast for the second quarter – coming in around a -0.2-percent annualized pace, and far below the 2.6-percent expansion posted in the first three months of the year. Housing investment weakened, inventory accumulation shrank, and exports slumped, adding to growing weakness in consumer demand to bring the headline print down.

Contribution to percentage change in real gross domestic product, Q2 2023

If the economy’s trajectory is sustained for another three months, the country could fall into a technical recession, suggesting that the Bank of Canada’s monetary tightening efforts have overshot the “soft landing” runway. The Canadian dollar is pushing through the 1.3550 mark as we go to pixels, with steady gains in crude prices helping to offset disappointment on the growth front. The front-month West Texas Intermediate benchmark is trading near year-to-date highs, up almost 6 percent this week alone, as the Saudi-led OPEC+ group of exporters cuts output in an attempt to offset surprisingly-weak demand from China.

The Mexican peso plunged more than 1.7 percent yesterday – and is adding to its losses this morning – after the Banco de Mexico said it would unwind its dollar hedging program in a phased manner, with rollovers beginning to shrink in the weeks ahead. The hedging programme, which was originally put in place in 2017 during Donald Trump’s rhetorical attacks on the country, might be more accurately thought of as a form of currency intervention – it followed Brazil’s use of swaps and non-deliverable forwards to bolster the real’s value without dipping into foreign exchange reserves, and was specifically designed to defend the peso against a speculative selloff.

We find it difficult to explain the scale of the reaction: with an estimated $7.5 billion in remaining notional (which will be unwound slowly), the amounts involved are diminishingly small when set against the stock of foreign direct investment in Mexico – somewhere north of 650 billion – and when dropped into daily turnover volumes exceeding $110 billion.

But markets may be responding to a perceived shift in the central bank’s reaction function: if policymakers are beginning to put inflation worries aside as they prepare for a downturn in economic growth (we think they are), and believe that the peso is trading well above fundamental value (as we do), the move could serve as advance notice of an eventual buildup in foreign currency reserves and a willingness to allow interest rate differentials to narrow.


The euro remains weak after a record from the European Central Bank’s last meeting showed officials expressing deeper concern about a weakening economy, with emphasis “put on the merit of sticking to a data-dependent, meeting-by-meeting approach in an uncertain environment”. According to the minutes, some argued that another rate hike could prove necessary without “convincing evidence that the effect of the cumulative tightening was strong enough,” while others argued “that it was quite probable that the September ECB staff projections would revise the inflation path sufficiently downwards toward 2 percent, without the need for another interest rate hike in September”.

Data throughout in the week has exhibited clear signs of a slowdown, with purchasing manager indices and credit conditions turning down. According to the August bloc-wide inflation report, growth in services prices is beginning to decelerate. And Executive Board member Isabel Schnabel’s comments yesterday were indicative of a somewhat-stagflationary outlook, with “growth prospects being weaker than foreseen,” even as “underlying price pressures remain stubbornly high”.

Odds on a move at the September meeting are now hovering around the 25-percent mark, putting a ceiling on the common currency’s gains.

Asia Pacific

The People’ Bank of China last night slashed the amount of foreign currency banks are required to keep in reserve, attempting to lift the renminbi by increasing liquidity in the dollar and euro.
The central bank cut the required foreign currency reserve ratio from 6 percent to 4 percent, effective September 15 “in order to improve the capacity of financial institutions to use foreign exchange funds”. Earlier, the biggest state-owned banks cut benchmark rates on existing mortgages, and several major cities – including Beijing and Shanghai – cut downpayment requirements and interest rates on new loans.

The yuan briefly touched a three week high before reversing lower. The government’s moves might be more important from a signalling perspective than in a fundamental sense: a significant share of the country’s mortgages are already set near the floor rate, and buyers will likely remain hesitant to invest in a property market facing headwinds as the economy slows, urbanization decelerates, and the population ages. We think confidence will improve, helping to boost domestic demand, but suspect further, more comprehensive steps will be needed to achieve a more complete reversal in market sentiment on the yuan.

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Higher for (even) longer