The NFP on Friday gave the markets a lot to chew over, as the data pointed in opposite directions. What that means is that the market is waiting for more clarity to fully price in what to expect from the Fed’s rate decision next week. The deciding factor here could be what happens tomorrow with US CPI.
The market definitely expects there to be a Fed rate cut. What hasn’t been resolved is by how much. For now, traders are pricing in a 75% chance of a quarter-point cut. The remaining 25% chance is for a “double” 50 bps cut. That probably is only slightly changed in favor of the less easing option that in twas before the NFP data or, even a week ago.
The Indeterminate Results
There are several factors complicating the prediction for what the Fed will do. First, we are getting this barrage of data while the Fed is in its pre-rate decision blackout. So, there won’t be any commentary from FOMC officials to clarify their stances on the data. Additionally, the working theory for the rate cuts is that the Fed has pivoted from worrying about inflation to being concerned that the unemployment rate might go up too much.
Friday’s contradictory data threw a significant wrench into the works. Non-Farm Payrolls beat expectations by 22K, but prior data was revised lower by over 86K. Taking that into account, the total number of jobs created was fewer than anticipated. On the other hand, the unemployment rate unexpectedly dropped by one decimal to 4.2% from 4.3% prior. How big of a change that is also matters, because it could be a relatively small number that appears bigger due to rounding. Finally, average hourly earnings rose faster than expected, staying above the inflation rate, which is interpreted as a sign of tightness in the labor market – the opposite of what the Fed would be worried about if it was considering its second mandate of full employment.
Where Do We Go From Here
Maybe the reason the market didn’t react so much is simply because it didn’t know what to do with that kind of data. August saw markets dipping substantially on recession worries due to low jobs numbers. Well, those jobs numbers were revised even lower. On the other hand, the unemployment rate uses a different methodology than the NFP survey, so it might provide a better view of what the underlying labor situation is like.
If the labor market is uncertain, the markets would really like some certainty from the inflation numbers. Traders seem to have become quite comfortable with the assumption that inflation will keep going lower, justifying an extensive rate cutting cycle by the Fed. But markets could end up disappointed and react poorly if the trend isn’t maintained. Or, possibly worse, once again showing some contradiction in the trends, with one number missing and another beating.
What to Look Out For
Headline US CPI is forecast to continue dropping to 2.7% from 2.9% prior, although on a monthly basis it is seen unchanged at 0.2% growth rate. The core rate, which is more closely followed by the Fed, is expected to remain unchanged at 3.2%, despite the monthly rate ticking up to 0.3% from 0.2% prior.
Shelter has been one of the key components driving consumer costs lately, and will likely be closely watched. With interest rates coming down in anticipation of the Fed easing, traders will be looking to see whether there are any signs of decompression in the system which would help gauge the reaction to the actual interest rate cut.
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