After Fed Chair Powell put the labour market front and centre at Wednesday’s FOMC meeting, all eyes have been on employment indicators in recent days. Those readings have proven unanimously disappointing, capped off by today’s nonfarm payrolls which undershot expectations by a significant distance, landing at just 114k.
Even worse, the weak payrolls signal was confirmed by the unemployment rate, which unexpectedly jumped from 4.1% to 4.3%, triggering the Sahm rule. All told, this looks like the US soft landing is turning into a plane crash, with the Fed having held policy too tight for too long. If markets were already spooked heading into this afternoon’s release based on leading labour market indicators, today’s data will have done little to help.
With this in mind, we wouldn’t blame Fed officials for digging through the details of today’s job report, trying to find some reason for optimism. Unfortunately, this latest report is likely to offer cold comfort. At best, it could be argued that the underlying data is still consistent with a soft landing. More realistically, the labour market is unwinding at pace, with recession risks climbing in tandem. Today’s 114k jobs print is well below the average monthly gain of 215k over the last 12 months. Moreover, the private payrolls reading fell from 136k to 97k, while the two-month net payrolls revision subtracted -29k jobs from the May and June readings. In terms of the makeup of jobs added, health care added 55k jobs in July, accounting for almost half of net gains, with the second largest contribution coming from construction at 25k.
Information employment, meanwhile, declined by 20k last month, with this mix of job gains and losses suggesting a decline in aggregate worker productivity. Not only that, but Hurricane Beryl, which some sell-side desks had suggested could weigh on payrolls by as much as 30k last month, had little impact according to BLS statisticians.
Turning to the household survey, this largely confirmed the message offered by the establishment report. Average hourly earnings fell from a downwardly revised 3.8% YoY in June, to 3.6%, with wages growing by 0.2% MoM in July. On an annual basis, this rate of wage growth is now level with the pre-Covid peak, recorded in February 2019. Tight Fed policy and embedded momentum are likely to see this fall further in the coming months, suggesting that while wages may have normalised for now, downside risks loom large. To this point, headlines are likely to focus on the unemployment rate jump – the half percent point increase in the three-month average from its low of the past year means that the Sahm rule has been triggered. Admittedly, we doubt a recession is currently underway as the rule predicts given that this is not the result of rising layoffs, but rather, an expansion in the labour force which has kept job gains positive. Nonetheless, a further unwind in the labour market now looks likely with the Fed still yet to move on policy rates, an outcome that suggests building recession risks to us.
From an FX perspective, the dollar’s reaction to this latest data has been curious. A US recession would see a significant slowdown in growth globally given that both the eurozone and China continue to post disappointing economic numbers.
Even so, this has not yet seen the greenback receive a haven bid, we think for two reasons. First, a soft landing remains on the table for now, provided the Fed delivers rapid policy easing. Second, that policy easing would see a notable erosion of the dollar’s carry protection. Both of these dynamics favours greenback downside. This seems to be the scenario that markets are pricing for now – swaps imply more than four rate cuts through the remainder of this year – they had predicted 2.5 immediately following Powell’s press conference on Wednesday. Even so, we are sceptical that this can be a durable theme for FX traders. There can only be so many weak US readings before spillover effects see the dollar pick up its typical haven bid.