Today, just over a week since Chair Jerome Powell alluded to a deceleration in the Fed’s hiking cycle at the July meeting, payrolls data highlighted that labour demand still remains high in the US economy, endorsing the messages from other FOMC members this week that the Fed will need to continue tightening policy at a faster pace.
In response to the strong beat in the data, swap markets began to price a third successive 75bp hike as their base case, with the US yield curve inverting further as the 2-year Treasury yield leapt some 18bp higher. The 2-10 spread, a traditional measure of recession risk, now sits at its most inverted since mid-2000. With higher interest rates being priced back into US interest rates, the dollar is back on the offensive as it notches gains in excess of a percentage point against all higher-beta G10 currencies, which led gains against the greenback in the wake of last week’s Fed meeting, while the yield sensitive yen continues to sell-off despite abundant recession concerns in major economies.
A 75bp hike in September becomes the market base case following the strong payrolls report
The US labour market added 528k jobs in July, more than doubling expectations for a slowdown in hiring to 250k, bringing both the total nonfarm employment and unemployment rate back to February 2020 pre-pandemic levels for the first time.
This runs against the signs in corporate earnings calls and the soft survey data, such as July’s ISM and PMI reports. Job gains were broadbased in July, with all sectors of the labour market exhibiting flat or positive employment growth. The largest net employment increase occurred within the leisure and hospitality sector (+96k) as it still struggles to recover to pre-pandemic levels of employment.
However, strong employment gains were visible in sectors where employment levels sit above pre-pandemic levels and are less sensitive to cyclical factors, such as profession and business services (+89k in July, +986k vs Feb 2020).
Although there are some reasons for the doves to push back against the headline signal from today’s data, such as the employment-to-population ratio still sitting at low levels, the overall impact of such a strong net employment increase is too overwhelming for bond markets to ignore. While there remains another Nonfarm payrolls report for August ahead of September’s meeting, along with two inflation reports, the momentum now sides with the Fed hawks as the bar for a softening in conditions to warrant a 50bp hike is pushed higher.
Higher beta currencies along with the yen lead losses against the dollar following a strong payrolls report
Simon Harvey, Head of FX Analysis