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4 Ways Friday's Jobs Report Can Change Fed Rate Strategy

4 Ways Friday's Jobs Report Can Change Fed Rate Strategy

Wednesday, 03 July 2019 08:02 AM

This week’s U.S. jobs report could make the case for the Federal Reserve to hold off on an interest-rate cut -- or to take even more drastic action.

The market is currently pricing in a bit more than a quarter-point of easing for this month’s Federal Open Market Committee meeting, meaning a 25-basis-point cut is seen as all but certain, and a 50-basis-point reduction is a possibility. That could all change rapidly on Friday if the jobs report strays too far from consensus forecasts, sending analysts and investors alike scurrying to adjust their views.

The median estimate of economists is for payroll gains to rebound in June to 164,000. Unemployment probably held at a half-century low of 3.6%, while wages likely gained 0.3% from the prior month and 3.2% from a year earlier, which would be improvements from May’s data.

A great report could keep the Fed on hold, buoying Treasury yields. That could in turn drag down stocks, though investors would be weighing that against a rosier economic backdrop implied by a healthier labor market. Conversely, a dismal report could push Treasury yields even lower, and depending on the details, provide a lift to riskier assets.

Markets could also be more volatile given the data’s release after Independence Day, with many people already on long holiday weekends. For his part, Fed Chairman Jerome Powell said last month that “we don’t like to look at one job report. We like to average over three or six months.”

With a number of moving parts to the report -- including revisions to prior months -- any number of permutations are possible, but here are four broad scenarios and what they may mean for both the central bank and markets:

1. Blockbuster

  • Scenario: Payroll gains top 200,000, unemployment drops, wages exceed forecasts.
  • Fed outlook: Probably on hold in July -- but it depends if officials can “successfully push back against market expectations for the cut,” said Michelle Meyer, head of U.S. economics at Bank of America Corp.
  • Counterpoint: Unless it’s a really strong number, around 300,000 or more job gains, the Fed is “still going to be very measured and cautious in how they interpret that better-than-expected number,” said Sam Bullard, senior economist at Wells Fargo & Co. He emphasized the Fed is looking at trends, not any one number.
  • Market reaction: Forget pricing of a half-point cut in July. Treasuries may decline, pushing yields higher. But stocks may be mixed, balancing the positives of a strong economy with the negative of less chance of easing from the Fed, said Ed Campbell, portfolio manager and managing director at QMA LLC.

2. Near Consensus

  • Scenario: Payrolls rise from 140,000 to 185,000, unemployment holds at 3.6%, wages in line with forecasts.
  • Fed outlook: Many economists still expect a quarter-point rate cut in this case, as policy makers seek insurance amid trade uncertainty, tepid business investment and subdued inflation. “The hurdle is pretty high” to forgo easing in July, said Kevin Cummins, senior U.S. economist at NatWest Markets.
  • Counterpoint: This may be enough evidence of a strong labor market to keep the Fed on hold, though concerns around trade and inflation could still prompt a cut. “If the Fed is easing, they’re not easing because of the jobs market for the most part,” said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC.
  • Market reaction: Probably a relief rally across equities, said Samantha Azzarello, global market strategist for JPMorgan ETFs. Treasury yields would likely only edge lower in this scenario given reduced pricing of a half-point rate cut, said Jon Hill, rates strategist at BMO Capital Markets.

3. Weak Across the Board

  • Scenario: Hiring below 100,000, unemployment rate rises, wages trail estimates.
  • Fed outlook: A half-point cut becomes more likely with meaningful cracks visible in the labor market. “That would maybe suggest that the slowdown that is happening in the economy could be actually sharper than we are anticipating,” said Lydia Boussour, senior U.S. economist at Oxford Economics, who currently expects a quarter-point reduction.
  • Counterpoint: The trade truce between the U.S. and China could potentially provide some relief not reflected in June indicators. And there are still more than three weeks of data before the Fed decision on July 31, including consumer spending, inflation and regional factory sentiment.
  • Market reaction: “Bond markets have already priced in the bad news to a certain extent, but equity markets have not,” said Frances Donald, chief economist for Manulife Investment Management. It might not be a turning point for stocks, but equity investors may become “a little bit more nervous.”

4. Wild Card

  • Scenario: A tightening labor market. Weak hiring, but unemployment falls and wages exceed estimates.
  • Fed outlook: The focus may shift to other data in the coming weeks ahead of the central bank’s meeting.
  • Counterpoint: A rate cut could still happen given trade tensions and a gradually slowing economy. “All these crosscurrents are still going to be present, and I think that’s the concern for the Fed,” said Boussour of Oxford Economics.
  • Market reaction: Equities may decline on diminished expectations for an interest-rate cut, while the bond market may “sell off a little bit” after rallying so much recently, said Shawn Cruz, manager of trader strategy at TD Ameritrade.

What Our Economists Say

“A sub-100,000 print would put the Fed on track to cut rates soon, whereas a result closer to Bloomberg Economics’ projection (150,000) will give leeway to deliver accommodation slower and to a lesser degree.”-- Carl Riccadonna, Yelena Shulyatyeva and Eliza Winger

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This week's U.S. jobs report could make the case for the Federal Reserve to hold off on an interest-rate cut -- or to take even more drastic action.
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Wednesday, 03 July 2019 08:02 AM
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