Market expectations of US Federal Reserve monetary policy have been fickle, but at this point, the ‘misery index’ still points to interest rate cuts in the coming year. Across the Pacific, mounting Sino-Japanese tensions could hit Japan’s economy and the outlook for the Bank of Japan’s (BoJ) policy.
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The US jobs report conundrum
September’s long-overdue jobs report looked strong on the surface with 119,000 non-farm jobs and 97,000 private jobs created, but the data was softer underneath: the previous two months’ jobs numbers were revised down by a total of 33,000 and the unemployment rate rose to 4.4%, the highest rate since 2017 outside the Covid period.
For policymakers at the Fed, the jobs market poses a conundrum.
On the one hand, solid hiring and steady, moderating wage gains give monetary policy hawks arguments for not cutting rates later this month.
On the other hand, higher unemployment pushing up the misery index (the sum of the unemployment rate and the inflation rate; see Exhibit 1) alongside weakening consumer confidence provide the rate-setting doves with ammunition for cuts.
The Conference Board survey, released last week, showed consumer confidence fell sharply in November to 88.7 from 95.5 in October. Data on concerns over the present and future labour market situation deteriorated notably.
Meanwhile, retail sales excluding food services, cars, building materials, and petrol fell by 0.1% month-on-month in September (in a shutdown-delayed release) and showed broad-based weakness, after rising by between 0.5% and 0.9% in each of the three preceding months.
Intriguingly, official data shows that the number of new entrants into the US labour market has surged since April this year alongside the rise in the misery index (see Exhibit 2).
While there is no official explanation for the expansion of the labour force, it could be that more people at the lower end of the income range are trying to cope with higher prices and uncertain wage prospects by looking for jobs, thus boosting the unemployment rate.
K-shaped recovery and Fed policy
With some data showing parts of the US economy are doing fine (if not prospering) and others showing weakness (possibly due to AI displacement and a productivity shock), it appears that the economy might be going through a K-shaped recovery.1
In such a scenario, company profits may grow without much (additional) hiring. This could imply that the solid job gains seen in September may not last and wage growth could decline further.
With all that, the upside risk to inflation may be capped, while the downside risk to the labour market may increase. Under these circumstances, the Fed could decide to accommodate a positive supply shock with lower interest rates, so that demand growth can catch up with the supply expansion of the economy.
Reports that Kevin Hassett, director of the National Economic Council and a supporter of President Donald Trump’s rate-cut and deregulation policies, could be the next Fed chair further revived market expectations that the Fed could adopt a lower-rate policy.
Japan’s ‘headache’ with China
Across the Pacific, political relations between China and Japan have worsened after Japanese Prime Minister Sanae Takaichi’s comments on Taiwan a few weeks ago. She said Japan might respond with military force if Taiwan were to face a ‘survival-threatening situation’ (implying an attack by China).
This touched political nerves in China, prompting it to respond by suspending all diplomatic, economic, financial and cultural exchanges with Japan until further notice. Hong Kong has largely followed suit. China is also cutting imports of some Japanese goods, notably seafoods. There are no signs of de-escalation anytime soon.
Potential economic impact on Japan
The situation is reminiscent of 2012 when Sino-Japanese relations plummeted due to a territorial dispute over the East China Sea.
At that time, Chinese consumers boycotted Japanese goods, hitting Japan’s exports to China especially hard in cars and related products. Although the impact on intermediate goods exports was relatively limited, things could be different this time (see below). It took a few years for the relationship to normalise.
Last time, Japanese exports to China and the number of Chinese tourists going to Japan dropped after the spat erupted (see Exhibit 3).
The same is happening this time. However, with China moving up the technological ladder, many exports of Japanese immediate goods to China are more easily replaced by Chinese products than in 2012, implying that a broader spectrum of Japan’s exports to China could be affected.
Crucially, inbound tourism from China has been significant: Chinese tourists spend almost 10 times more in Japan now than in 2012. Inbound tourist expenditure accounted for 1.3% of Japan’s GDP in 2024, with over 20% coming from China.
If not resolved soon, Sino-Japanese political tensions could add a downside risk to Japan’s economy, complicating the assessment by investors of its market and policy outlook.
[1] A K-shaped recovery is when one part of the economy rebounds from a slowdown or recession and another part continues to decline.
