The surprisingly weak U.S. jobs report this morning has not only spurred speculation on whether the U.S. Federal Reserve will cut its key interest rate by an aggressive 50 basis points next month - but it also has market players pondering the possibility that the Bank of Canada may need to accelerate its monetary easing as well.
The market was bracing for a weak U.S. nonfarm payrolls report this morning following unexpectedly soft weekly U.S. jobless claims on Thursday.
But it still managed to surprise. Nonfarm payrolls increased by 114,000 jobs last month after rising by a downwardly revised 179,000 in June, the Labor Department’s Bureau of Labor Statistics said. Economists polled by Reuters had forecast payrolls advancing by 175,000 jobs. The unemployment rate increased to 4.3%. Job wage gains also slowed.
The U.S. rate futures market is now pricing in a 65% chance of a 50 basis-point cut at the Sept. 18 Fed meeting, up from 19% late on Thursday. The market has also priced in about 110 basis points in cuts this year, from 75 basis points on Thursday.
All this is trickling down into Canadian markets, pushing key bond yields lower as traders reassess the outlook for rate cuts in this country given concerns the U.S. could be on the brink of a recession. The Bank of Canada has already cut its trend-setting overnight rate by a quarter of a percentage point twice this year, while the Fed so far has kept its key interest rate unchanged.
Both Canada’s five-year and two-year bond yields were down 10 basis points in morning trading to their lowest levels in just over two years. The five-year yield is closely watched because of its influence on fixed mortgage rates, while the two-year is particularly sensitive to shifts in the outlook for Canadian monetary policy. Bond yields are down even more in the U.S. as traders react to the U.S. employment report, with the two-year down about 20 basis points - a big one-day move for bond markets.
For the first time this economic cycle, implied probabilities in swaps markets suggest traders are pricing in modest - but not insignificant - odds that the Bank of Canada will cut interest rates by an aggressive 50 basis points at its next policy meeting on Sept. 4.
Money markets suggest at a minimum the bank will cut rates by a quarter point at each remaining policy meeting this year - with some risk that there will be an additional quarter point thrown in at some point in the next five months.
Here’s how implied probabilities of future interest rate moves stand in swaps markets, according to data from LSEG as of 850 am ET. The Bank of Canada overnight rate is 4.50 per cent. 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 a look at the probabilities when it comes to how much the bank may cut in September.
A 25 basis point Bank of Canada rate cut in September is still seen as the most likely scenario by money markets. But there is 100% certainly now, based on market pricing, a cut of some sort will arrive. Just a week ago, the market-implied odds of a quarter point cut at the bank’s next meeting were at about 70%.
The Canadian jobs report for July comes out next Friday, and it’s expected to show more softening in the labour market. RBC is currently predicting only 15,000 new jobs added, with the unemployment rate ticking up to 6.5% from 6.4% in June.
Here’s what some economists and market strategists are saying about the U.S. jobs report and its impact on monetary policy stateside:
Doug Porter, chief economist with Bank of Montreal
And, now, whither the Fed? Markets and analysts were busily revising down their forecasts for fed funds in the wake of this week’s developments. To be clear, it’s not just driven by the employment figure—indeed, payrolls weren’t overtly weak, they could easily be revised, and they’re still up a sturdy 1.6% y/y. No, the much bigger concern is the grinding rise in the jobless rate and the lack of growth in household employment. We believe that the case for restrictive rates has almost vanished, and the Fed will now proceed with haste to get back to something approaching neutral. Accordingly, we are revising our call to include a series of consecutive cuts, including in the final three meetings of this year, and the first two of next year. We are maintaining our call on cumulative cuts of 225 bps, for now, but see the Fed getting there much faster. And any serious stumble by the economy could prompt bigger gulps than 25 bp steps, although we’re not quite there yet. In turn, we are also revising our Bank of Canada call somewhat. With the Fed expected to get a bit more forceful, this opens the door for the Bank to match its own dovish stance with faster action. We now look for the BoC to cut in each of the next four meetings, quickly taking their overnight rate down to 3.5% by January (from 4.5% now), and then to 3.0% by mid-2025. That means the Bank will arrive at the presumed end point more than half a year earlier than expected. We had warned that the risk was for sooner/faster, and a milder Fed certainly provides the cover for the Bank to follow. As Ferris might say, life moves pretty fast when the economy slows.
David Rosenberg, founder of Rosenberg Research
There was absolutely no silver lining or redeeming feature in this report. The Fed is behind the economic curve to the same degree it was behind the inflation curve back in 2021 and 2022, and there will be hell to pay for this policy misstep — especially given the tense political environment with an election just three months away.
Stephen Brown, deputy chief North America economist, Capital Economics
The sharp slowdown in payrolls in July and further rise in the unemployment rate cast doubt on the Fed’s argument mid-week that it is still too soon to loosen policy. We now expect 25 bp cuts at each of the remaining three meetings this year and will be watching for signs that a larger 50 bp move could be on the cards, although that would be dependent on the economy and labour market weakening at a faster pace than we forecast.
Taylor Schleich, Alexandra Ducharme and Jackson Atkinson, economists with National Bank Financial
To put it bluntly, this morning’s data was terrible for those in the ‘soft landing’ camp. A miss on headline job creation and the fourth straight higher-than-expected print on the jobless rate offers more evidence that the Fed’s assessment of a strong labour market is misguided. ...
Let’s step back for a moment. Just two days ago, the Fed more formally emphasized the full employment side of its dual mandate. While that was appropriate, it’s come far too late as these data are increasingly indicating. Even before this morning’s release, we’ve seen a steady softening in labour market conditions, including in yesterday’s jobless claims data. JOLTS earlier this week technically came in stronger than expected but remains far below 2022-2023 levels. The ratio of job openings to unemployed workers is back to 2019 levels while the quits rate is below where it was on the eve of the pandemic, indicating much less confidence in job market prospects. This assessment is consistent with most ‘soft data’. ...
While the Fed and other commentators may point to the historically low level of the unemployment rate as a sign that the labour market is in good shape, we’d stress that moves in unemployment tend to be non-linear. In other words, when it begins rising it’s hard to abate and weakness can feed on itself. That’s why there’s been an increasing focus on the Sahm recession indicator (when the 3M moving average of the unemployment rate rises by 0.5%-pts over the minimum of the 3M average from the previous 12M). On a rounded basis, that was triggered (+0.533%-pts) today but for those calculating monthly unemployment rates to the exact decimal you’ll technically see a +0.494%-pt increase. In any case, the increase is concerning. Importantly, we don’t think Fed rate cuts can save the labour market either. Historically, the jobless rate continues rising even after cuts begin. The softening we’ve seen since the Fed’s last hike in July 2023 is already more than we typically observe.
What does it all mean for the Fed? Well, Powell had already indicated the labour market is not a source of significant inflationary pressures and he said they didn’t want to see material further softening in the labour market. So, even if this report had come out looking solid, a cut was still very likely barring a material inflation surge. After today, there’s not much inflation can realistically do to take a cut at the next meeting off the table. We’d venture to guess the debate for the next seven weeks will be whether the Fed should cut 25 or 50 basis points in September. For now, 25 bps is the safer bet but if August jobs data resemble what we’ve seen today, that probability is likely to swing. Either way, the Fed will probably feel comfortable easing at each of the final three meetings of the year. We’ve long been pessimistic about the U.S. outlook and unsurprisingly remain so. As such, we see rate cuts continuing at a steady pace in 2025 and expect the Fed funds target to set below 4% by this time next year.
Derek Holt, vice-president, Scotiabank Economics
Nonfarm payrolls disappointed expectations and increased by only 114k and the household survey registered just +67k. If that’s accurate, then it signals a sudden deceleration of job growth to a pace that lies beneath estimates of the required breakeven pace in relation to the pick-up in population growth.
Markets reacted violently ... And yet we may have seen this movie before. Like a typical Disney flick, it’s entirely possible that apparent initial adversity ends more positively. ...
We are still being plagued by the distorting aftermath of the pandemic. Weak job growth in July 2024 is a repeat of the past pattern of reports at this time of year. On a seasonally unadjusted basis, this July was actually a little better than the pre-pandemic norm. So why did SA [Seasonally Adjusted] job growth disappoint? The rub lies in the seasonal adjustment factors that were applied. ...
The pandemic era dominates the weakest seasonal adjustment factors applied to months of July in history. This means that the typical seasonally unadjusted decline in employment that happens in months of July has been serially undercompensated by seasonal adjustment factors during the pandemic era.
If instead of using the BLS SA factor for July 2024 that generated this morning’s +114k print we were to apply the average SA factor for months of July up to and including 2019 before the pandemic struck the next year, then this July’s nonfarm payrolls would have been up by about 200k instead of 114k.
By extension, SA factors were distorted in a way that arguably overstated nonfarm payrolls growth earlier in the year such as the 310k surge in March which was the month in 2020 when all heck broke loose and economies began to shut down.
This is an extension of Chair Powell’s point about inflation during his recent press conference and why he looks at full year data. In the inflation context, distorted seasonal adjustments may artificially inflate price increases earlier in the year and artificially deflate them later. Ergo, consider the totality of the year’s evidence. The same argument applies to evaluating jobs.
There is also the issue that this is just one month by the way. And we’ve seen one-handled payroll changes in the past, such as 108k in April right after March’s barn burner of a report. Or three months of 100k range prints last year.
Markets may have also had such a violent reaction to the payrolls estimate because, well, it’s August. Pair data disappointment with holidays and you have the recipe for a violent reaction.
Katherine Judge, senior economist with CIBC
It’s only one data point on its own, but coming on the heels of other soft reports this past week, today’s labour market news adds to the evidence that the upside surprise in Q2 growth is giving way to a less rosy climate this summer. ... A Fed rate cut in September was already a given and has long been in our forecast, but we’ll have to give some thought to adding a third quarter point cut to our existing forecast for only two cuts from here to year end. That said, there’s a lot of data to come before the Fed has to make that decision, and the CPI trend will also be an important consideration for the pace of rate cuts ahead.
The balance of risks for a dual mandate central bank is now shifting towards too few jobs, rather than too much inflation. While Powell has discounted the validity of the Sahm Rule, today’s rise in the unemployment rate would be consistent with what in the past has represented the start of a recession. We’ll likely nudge our Q3 growth forecast down somewhat, although for 2024 as a whole, the upside surprise in Q2 will be an offset.
Dominique Lapointe, director of Macro Strategy for Manulife Investment Management
It is difficult to find a silver lining in the July nonfarm payrolls report. Payroll gains were +114 and missed the consensus by a wide margin. Similar to what we observed the entire year, revisions to the two prior months came in negative, suggesting that smaller businesses who regularly fill out the survey a bit later hire much less than larger firms who answer more quickly. It is also worth pointing out that payrolls only grew +40K after excluding health, education and government workers. In other words, industry private hiring came dangerously close to a net loss. Meanwhile, the labor force in the household survey grew a staggering +420 while only +67K jobs were added. This boosted the unemployment rate to 4.3%, now 0.3ppts above the Fed’s latest forecast.
Claire Fan, economist, Royal Bank of Canada
The U.S. labour market started the third quarter with a downside surprise. The July data also marked a clear deceleration in labour market conditions that had been gradually unfolding through the past year. The unemployment rate rose to 3.9% in April from 3.4% in the April of 2023, and then rose to 4.3% within the span of three months. In the press conference for the Fed meeting this week, Powell continued to characterize ongoing labour market weakening as conditions normalizing from being overheated. He did stress that the Fed will be ready to respond “if labour market were to weaken unexpectedly.” We continue to expect the Fed will cut interest rate at the next meeting in September, and see risks tilting towards more cuts than less for the rest of this year.