A soft US payrolls report could seal a Fed pause later this month

After 6 days of gains, the FTSE100 ended the month on a sour note bringing the curtain down on a negative month for European markets, as sentiment soured somewhat on concerns over the outlook for interest rates, and the China recovery story.

US markets also ended a similarly negative month on a downbeat note, although we have seen a shift in some of the negative sentiment in the past few days due to softer than expected US economic data which has brought yields lower and encouraged the idea that this month’s Fed meeting will see US policymakers vote to keep rates on hold.

This week we’ve seen the number of job openings for July slow to their weakest levels since March 2021, a sharp slowdown in August consumer confidence, a weaker than expected ADP payrolls report, and a downgrade to US Q2 GDP.

US continuing claims also rose sharply to a 6-week high, suggesting that recent rate hikes were starting to exert pressure on the US economy and a tight labour market.

If today’s non-farm payrolls report shows a similarly modest slowdown in the rate of jobs growth, then there is a very real sense that we could see further gains in stock markets, as bets increase that the Federal Reserve may well be done when it comes to further rate hikes. At the very least it could go some way to signalling a pause as the US central bank looks to assess the effects recent rate hikes are having on the US economy.

In July we saw another modest slowdown in jobs growth, along with downward revisions to previous months. 187k jobs were added, just slightly above March’s revised 165k, although the unemployment rate fell to 3.5%, from 3.6%.

While the official BLS numbers have been showing signs of slowing, up until this week’s 177k, the ADP report had proven to be much more resilient, adding 371k in July on top of the 455k in June.

The resilience in the US labour market is also coming against a backdrop of sticky wages, which in the private sector are over double headline CPI, while on the BLS measure average hourly earnings remained steady at 4.4%, and are expected to stay around this level.  

Today’s August payrolls are set to see paint another picture of a resilient but slowing jobs market with expectations of 170k jobs added, with unemployment remaining steady at 3.5%, although it is important to remember that whatever today’s jobs numbers tell us, vacancies in the US are still well above pre-Covid levels on a participation rate which is also lower at 62.6%.

After the payroll numbers we also have the latest ISM manufacturing report which is expected to continue to show that this part of the US economy is in contraction territory for the 10th month in a row.

Before today’s US payrolls report, we’ll also get confirmation of the dire state of the manufacturing sector in Europe with the final August PMIs from Spain, Italy, France and Germany, with expectations of 48.8, 45.7, 46.4 and 39.1 respectively.

UK manufacturing PMI similarly is also expected to be confirmed at 42.5 and the lowest level since June 2020.

Weak numbers here, along with similarly weak services numbers next week will also go a good way to ensuring that the ECB and perhaps even the Bank of England err on the side of a pause when they also meet later this month.

The bar to a pause for the Bank of England appears to be a much higher one, however yesterday’s comments from Chief Economist Huw Pill would appear to suggest that the MPC is already leaning towards the idea that monetary policy in the UK is already restrictive.

In a speech made in South Africa he said that he preferred to see a rate profile along the lines of a “Table Mountain” approach, in other words keeping them at current levels, or even a little higher for a lengthy period of time.

The contents of the speech appeared to suggest that while inflation levels remained elevated, there was an acknowledgement that a lot of the recent rate hikes hadn’t yet been felt, raising the risk of overtightening, and that monetary policy was already sufficiently restrictive. This would appear to suggest that a consensus is growing that the Bank of England could be close to the end of its rate hiking cycle, with perhaps one more at most set to be delivered in September.

There also appears to be an increasing debate over the sustainability of the current 2% inflation target as being too low given current levels of inflation, with arguments being made for increasing it to 3% or 4%.

The 2% target has been a key anchor of central bank monetary policy over the last 30-40 years, and while it has served a useful purpose in anchoring inflation expectations some are arguing that trying to return it to 2% could do more harm than good.

That may well be true, but there is also the argument that in moving the goalposts on the current inflation target now sends the message that central banks are going soft in getting inflation under control, and that rather than return it to target over a longer period, it’s easier to move the goalposts.

This comes across as unwise particularly in terms of timing. The time to have moved the inflation target was when inflation was below or at 2%, not while it is miles above it.

Optics are everything particularly when inflation is well above target, with central banks needing to send the message that inflation remains their number one priority, and not water down their long-term commitment to it because it’s too hard. The time to discuss a change of a target is when that target has been met and not before. Once that happens in perhaps 1-2 years’ time the discussion on an inflation target, or an inflation window of between 1.5% to 3.5% can begin.  

EUR/USD – the retreat off the 1.0950 area this week has seen the euro slip back with the 1.0780 trend line support from the March lows coming back into view. We need to push through resistance at the 1.1030 area, to signal a return to the highs this year. Below 1.0750 targets 1.0630.

GBP/USD – pushed up the 1.2750 area earlier this week but has failed to follow through. We need to push back through the 1.2800 area to diminish downside risk and a move towards 1.2400.    

EUR/GBP – having failed at the 0.8620/30 area earlier this week has seen the euro slip below the 0.8570/80 area. While the 50-day SMA caps the bias is for a retest of the lows.

USD/JPY – the 147.50 area remains a key resistance and remains the key barrier for a move towards 150.00. Support comes in at last week’s lows at 144.50/60.