Friday’s non-farm payrolls report failed to definitively settle the debate over the size of the Federal Reserve’s first rate cut. Markets initially added to bets on a plus-sized move after the Bureau of Labor Statistics reported a slower-than-anticipated pace of job creation through July and August, but soon reversed on evidence of underlying stability in labour markets – the unemployment rate edged lower, the prime age employment rate remained historically high, and growth in average hourly earnings showed signs of accelerating.
A widely-anticipated speech from Governor Waller didn’t clarify things much either. Odds on a half-percentage-point move shot up as his comments hit the wires, but then plunged as participants parsed the details more carefully. “As of today, I believe it is important to start the rate cutting process at our next meeting,” he said. “If subsequent data show a significant deterioration in the labour market, the FOMC (Federal Open Market Committee) can act quickly and forcefully to adjust monetary policy. I am open-minded about the size and pace of cuts … If the data supports cuts at consecutive meetings, then I believe it will be appropriate to cut at consecutive meetings. If the data suggests the need for larger cuts, then I will support that as well”.
With the market-implied likelihood of an emergency-sized rate cut now down to 25 percent*, short-term yields are higher, equity futures are modestly lower, and the dollar is kicking off the week on a substantially stronger footing.
Wednesday’s inflation report is unlikely to deliver the clinching argument. Markets think that the core consumer price basket climbed 0.2 percent in August for a second consecutive month, up 3.2 percent year over year. An outsized surprise could change investor assumptions about the economy’s underlying momentum, but we suspect this won’t have much impact – the focus among policymakers has clearly shifted toward the second half of the Fed’s mandate: away from price stability, and toward maintaining near-full employment.
Size matters. According to the popular narrative, a jumbo-sized move at next week’s meeting might convince markets that the long-dormant ”Fed put” is back in place, and trigger a rip-roaring rally in risk assets. On the other, it might act as a signalling device, telling investors that the economy is in worse shape than previously believed and leading to a broad-based selloff.
But the motion in the ocean might matter more. Markets expect the Fed to push rates below the 3-percent threshold by September next year, with six moves materially priced in by January. Financial conditions have eased significantly, mortgage rates are down, and credit is flowing to businesses and consumers in volumes that are not consistent with an economy on the verge of a recession. Consumer spending remains strong, bankruptcy filings are declining, and nowcasting growth models are pointing to an above-2.1-percent expansion in real gross domestic product in the third quarter.
The euro and pound are struggling to recover from last week’s losses. The European Central Bank is almost-universally expected to deliver a second rate cut on Thursday, and might express relatively cautious views in its accompanying communications, but data released on Friday morning showed wage pressures beginning to ease in the second quarter, potentially giving officials room to signal more easing in updated forecasts, and in appearances scheduled for the days after the announcement. The pound is trading near a two-week low in the run-up to tomorrow’s wage data, with cooling labour market pressures seen supporting market expectations for at least two more Bank of England cuts by year end.
The yen and yuan are also down, with the move mostly reflecting a US-driven narrowing in cross-Pacific rate differentials, but also influenced by worsening domestic fundamentals. An update published last night showed the Japanese economy expanding slightly less than initially estimated in the second quarter, modestly weakening the case for more monetary tightening. And a raft of data out of China illustrated the extent to which an ongoing collapse in household confidence has impacted price levels: the country’s consumer price index rose just 0.6 percent in the year to August, while the producer price measure – which drives manufactured goods costs on a global basis – plunged -1.8 percent, further bolstering the need for additional policy support.
The Canadian dollar remains on the defensive after signs of resilience in Friday’s domestic jobs report were overwhelmed by reaction to the US numbers. According to Statistics Canada, the country added 22,000 jobs in August – with gains and losses in part-time and full-time roles essentially washing out on a two-month basis – and wages climbed 4.1 percent on a month-over-month seasonally adjusted annual basis, significantly outpacing inflation.
The unemployment rate continued to grind higher, hitting 6.6 percent, but again, this was more reflective of an economy failing to keep pace with immigration than of a deep contraction in underlying growth. The ranks of recent immigrants and young people without jobs have swollen dramatically since reaching a low in June 2022 – suggesting that some in Ottawa should be concerned about their political futures, but that investors could be less worried about overall growth. For better or for worse**, it is older Canadians – particularly the baby boomers – which drive the bulk of the country’s spending.
*The chart depicts Friday’s session, odds have fallen further since.
**I’m inclined to think it’s for the worse, but as a younger member of ‘Generation X’, that probably comes with the territory. They did, after all, name my generation using the letter that best described our economic prospects. True story.