A much-weaker-than-expected U.S. jobs report has market participants rethinking the odds of a Bank of Canada interest rate cut at its next policy meeting in June.
Implied interest rate probabilities in swaps markets now suggest about a 78 per cent chance that the Bank of Canada will cut its key overnight lending rate on June 5, according to Refinitiv Eikon data. Just prior to this morning’s U.S jobs figures, those odds were less than 65 per cent. Markets are now fully pricing in a rate cut by the July meeting, signaling a high degree of confidence short-term interest rates will soon be heading lower.
The weak labour report has revived hopes that the U.S. Federal Reserve will cut its own key lending rate this year. That has a knock-on effect on where monetary policy is heading in Canada, since the two economies and financial markets are so closely linked. If the Bank of Canada aggressively lowers its key lending rate well ahead of any moves by the U.S. central bank, it would risk further depreciation in the Canadian dollar and the inflationary pressures that could ensue.
Money markets are now pricing in about 51 basis points of rate cuts from the U.S. central bank this year, compared with about 41 basis points prior to the data release, according to LSEG data.
The Labor Department report showed U.S. nonfarm payrolls increased by 175,000 jobs in April, compared with expectations for an increase of 243,000, according to economists polled by Reuters. The unemployment rate stood at 3.9 per cent compared with expectations that it would remain steady at 3.8 per cent, while average earnings rose 0.2 per cent on a monthly basis against forecasts of 0.3 per cent growth.
The following table details how swaps markets are pricing in further moves in the Bank of Canada overnight rate, according to Refinitiv Eikon data minutes after the U.S. jobs data were released. The current Bank of Canada overnight rate is 5%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.
And here’s how markets were pricing in monetary policy changes just prior to the data being released:
Bond yields in both Canada and the U.S. fell following the data. The U.S. two year at around 9am ET was down 10 basis points at 4.77 per cent and the Canadian two year was down about 5 basis points at 4.19 per cent. Two-year bond yields are particularly sensitive to central bank policy moves and are influential on the pricing in equity markets. Major North American stock indexes opened sharply higher this morning.
Here’s how economists and market strategists are reacting to the U.S. jobs data in written commentaries this morning:
Douglas Porter, chief economist, BMO Capital Markets
The coming meeting on June 5 is again seen as a very real possibility for the first cut, especially with the Fed potentially back in play in the summer. We have been calling for the BoC’s rate-cutting cycle to begin in June since late last year, and we are doggedly sticking to that call. While we never want to hang a rate decision on a single indicator, the [Canada] April CPI (on May 21) looms very large. BofC Governor Tiff Macklem has already signalled that the Bank expects inflation to stick close to the current 2.9% pace for a few months, due to a pop in gasoline prices (and we readily concur), but all eyes will be on whether core measures stay cool. The Bank will also see April jobs (next Friday) and the official Q1 GDP results (May 31) before deciding on rates. But perhaps the second most important indicator tipping the Bank’s decision will be the U.S. CPI (May 15). Even if the BoC can go it alone, it sure would help if it appeared that U.S. cuts would soon follow. So, like Leaf fans, we now look to the south for the next big result, and hope for the best.
Royce Mendes, managing director and head of macro strategy, Desjardins
It’s almost as if Jerome Powell had seen the payroll numbers when he stepped to the podium on Wednesday and delivered a more dovish than anticipated message. The US economy churned out just 175K jobs in April, the lowest since October 2023. Revisions to the prior two months were also net negative, albeit only modestly.
Much of the shortfall in job creation versus the consensus estimate of 240K for April came from the public sector, with the private-sector undershooting expectations by a narrower margin. Despite the advance in jobs, total hours worked during the month actually declined, suggesting a soft start for GDP in Q2.
Overall, the softer labour market in April had the unemployment rate rising a tick to 3.9%. That’s up from a low of 3.6% over the past year and is not very far below the Fed’s estimate of 4.1% for the natural rate of unemployment. The closely watched Sahm rule, which can be an early indicator of recessionary conditions, was not triggered. However, it continues to creep closer to that threshold.
Wages advanced just 0.2%, with the annual rate ticking down to 3.9% from 4.1% in March. While Powell downplayed any concerns about wage-push inflation earlier this week, the slowdown will no doubt be a sigh of relief for US monetary policymakers.
Today’s data reinforce the Fed’s decision to simply delay rather than derail their plan to eventually cut rates this year. Earlier this week, Fed Chair Powell had said that now that inflation is much closer to target, the employment side of the mandate will take more precedence in the FOMC’s decision making relative to the past few years when the sole focus was on taming price pressures.
Markets view these numbers as reinforcing the message that the next move in rates will be to the downside. Yields across the Treasury curve are down as it looks more likely that the current level of the fed funds rate is restrictive enough to put inflation back on track down to 2%. While policymakers will still want to see more evidence that price pressures are diminishing before considering any monetary easing, we are retaining our call for the Fed to cut rates twice later this year.
David Rosenberg, founder of Rosenberg Research
Well, we finally received a nonfarm payroll report that bore some resemblance to reality. ... For those who don’t think the Fed can pivot again in a more dovish direction, keep in mind that both the core PCE inflation rate (2.8%) and the unemployment rate (3.9%) are within just 20 basis points of the Fed’s latest projections for 2024 (and recall that when these freshly-minted forecasts were last published in March, the median dot-plot was still calling for three cuts, not one). Also keep in mind the emphasis that Chair Powell placed on the Fed’s dual mandate at Wednesday’s post-meeting press conference and that an unexpected weakening in the labor market would be a huge consideration for the start of the easing cycle. I would not for one second believe that this was a one-off.
Leisure/hospitality (wages +0.1%), education and health (+0.1%) and transportation and warehousing (flat) are all great signs from a Treasury market perspective because for the past two years, Jay Powell has been focusing his inflationary attention on these parts of the services sector. With wages cooling off substantially and the workweek contracting, personal income derived from the labor market dipped -0.1% MoM and this should weigh on consumer spending ahead (barring an even larger drawdown in the already-depleted personal savings rate).
The stalling-out in Q1 nonfarm business productivity was very important in this one respect: the message is that companies have over-hired and are now in the process of shedding their labor needs. The pace of job growth is slowing markedly and the contraction in the workweek is a telltale sign that the rightsizing of workplace requirements is going to persist, taking the unemployment rate up further and acting to depress wage growth. In the months ahead, we will no longer be hearing narratives of a red-hot labor market and sticky inflation and “higher for longer”. The April jobs report, from top to bottom, reveals an economic backdrop that is losing momentum.
Scott Anderson, chief U.S. economist, BMO Capital Markets
We received a very Fed-friendly employment report for April. U.S. payroll growth came in at a much more comfortable 175k jobs after an upwardly revised 315k in March, for once underperforming the consensus which was looking for a more gradual slowdown to 240k jobs. The report was light on almost every measure of labor market conditions, putting Fed rate cuts for 2024 back on the table for financial markets. The three-month moving average of nonfarm payroll gains slowed to 242k from 269k in March, so, even taking a broader perspective, the labor market seems to be cooling just as the Federal Reserve ordered. We believe these job numbers are right in the sweet spot for the soft-landing scenario the Fed has been hoping for, raising the odds of a September rate cut. ...
There wasn’t much not to like in the Employment Report for April. Both the Fed and the markets must be breathing a sigh of relief after that sizzling March report. This report adds to the growing evidence from other labor market indicators, such as the JOLTs report, that hiring is cooling, and the rebalancing of the labor market is already well underway. Fear not, the Fed’s monetary medicine is having the desired effect and a soft-landing outcome for the economy appears a lot closer than many thought.
Thomas Feltmate, senior economist, TD Economics
The U.S. job engine lost a bit of momentum in April, with payrolls printing below the 200k mark for the first time in five months. However, smoothing through the monthly volatility shows job gains have averaged a still healthy 242k over the past three-months, which is only a modest step down from Q1′s 269K, and still above Q4′2023′s average of 212k. Importantly, wage growth decelerated a bit more than expected last month. This will be welcome news for Fed officials – particularly after other data points out this week including the Employment Cost Index showed an uptick in wage pressures more recently.
By most metrics, the labor market remains both healthy and tight. Employment gains remain robust, the unemployment rate is low, and job openings – while falling – are still elevated relative to pre-pandemic levels. With the unemployment rate expected to hold steady through Q2, inflation is unlikely to ease in a way that would give policymakers enough confidence that it’s on sustainable path back to 2% until sometime in the second half of the year. As a result, we have pushed out the timing of the first Fed rate cut until December.
Ali Jaffery, senior economist, CIBC Economics
The Fed will be pleased with today’s data given Powell’s dovish bias, particularly the slower wage growth number and part-rate remaining steady, as both help with slower price gains going forward. But overall the labor market still remains strong and they will need to see more evidence of a slowdown, or a surprise sharp drop in employment, to be worried about their employment mandate after such a strong string of job gains. Ultimately, the FOMC is going to stay on hold until they have clarity on inflation. They are trying to assess whether the uptick in price pressures in Q1 is going to be persistent or not, and with the labor market not cracking, they have some time to figure it out. While we think the economy has more excess demand than the Fed seems to be letting on to, we also believe there is no small idiosyncratic part to the uptick in Q1 inflation which should pass, paving the way for a couple of [Fed] cuts this year.
Claire Fan, economist at Royal Bank of Canada
Today’s downside surprise in payroll employment follows a string of upsides. Still, unemployment has been (very gradually) creeping higher and hiring demand continues to slow. The job openings rate has been dropping since March of 2022, to a touch above levels pre-pandemic levels at last count in March. The slowing in wage growth also suggests inflationary pressures coming from labour market activities are easing despite the downside surprise in productivity in Q1. Fed chair Powell at the post FOMC press conference this week pointed to these indicators as evidence that higher interest rates are working to restrict economic activity, but stressed that more time is needed for it to ease price pressures. Contingent on inflation in the U.S. slowing back down throughout the year, we expect a first [Fed] rate cut to come later in December.
Paul Mielczarski, head of macro strategy, Brandywine Global, part of Franklin Templeton
Moderation in employment growth together with softer wage growth revives prospects for Fed rate cuts in the coming months. Our view has been that the surprisingly strong topline macro data is likely hiding some latent weakness. However, month-to-month employment numbers are notoriously noisy, so a June [Fed] rate cut likely is off the table. But if the next two inflation prints are softer, the Fed could realistically start cutting rates in July. Bringing forward Fed easing expectations supports government bonds, credit, and emerging market assets. It should also reverse the recent rally in the USD. The USD has benefited from the recent change in expectations for the Fed to remain on hold for most of 2024.
Emily Roland and Matt Miskin, co-chief investment strategists for John Hancock Investment Management:
We are seeing significant volatility in the bond market as prospects for growth/inflation shift widely based on incoming economic data. For example, in just over a week the 10-year treasury yield has dropped 20 bps – from a high of 4.70% last Thursday to 4.50% as of this writing – reflecting disappointing April data so far (in addition to today’s soft jobs report, this week consumer confidence fell to its lowest level in nearly 2 years, JOLTS job openings slowed, and the U.S. ISM manufacturing index dropped below 50). In our view, Q1 may have represented a “mini cycle” where we saw a pickup in growth and inflation that was fueled by the Fed suggesting as much as 3 rate cuts in 2024 (and the bond market pricing in 6). Now that rates are once again elevated, we may be moving back to a more normal growth rate (it’s tough for the economy to maintain above-trend growth with rates at restrictive levels). If a slowdown is starting to materialize, we would view any backups in bond yields opportunistically, as income at these levels is extremely attractive.
Derek Holt, vice-president and head of capital markets economics, Scotiabank
I don’t think Chair Powell will be swayed by the payroll figures and for two reasons. For one, he’s already onto the narrative that the job market is rebalancing away from excess demand for labour with a pick-up in population growth aiding the supply side while trend job growth is still strong enough to absorb new entrants. For another, the Committee’s focus is squarely upon the price stability part of the dual mandate where they need to see a resumption of progress toward lower core inflation readings after recently hotter ones. Barring a collapse in job growth, the focus in terms of easing policy will remain on inflation.
Economists at Goldman Sachs
Our estimate of the underlying pace of job growth based on the payroll and household surveys now stands at 189k, though we estimate that counting immigration fully would boost this by 20k, and our estimate of the underlying pace of average hourly earnings growth stands at +3.5%. Our Q1 wage tracker stands at +4.5% on a quarterly annualized basis and +4.3% on a year-over-year basis. We continue to expect two [Fed] rate cuts this year, in July and November.
Darcy Keith