After ending August at record highs, global stock markets fell in the first week of September. Investors reacted to worries over a weaker US economy. Nervousness ahead of the 6 September release of the latest US job report added pressure: the previous report had been one of the triggers for market turbulence in early August. Fluctuating expectations about the path of the US Federal Reserve’s monetary policy remain the main factor influencing moves in equity markets.
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Hard to say
Much like other recent employment data, this long-awaited report – The Employment Situation Summary by the Bureau of Labor Statistics – will leave many investors and the FOMC (Federal Open Markets Committee) unsure about the state of the US labour market.
While the latest data is weak enough to justify a September cut in key interest rates, it does not offer clear-cut evidence of the need for a 50-basis point (bp) cut.
The number of 114 000 net job creations in August (vs. the 142 000 expected by the Bloomberg consensus) was all the more disappointing as the figures on the previous two months were revised down (by a cumulative 86 000). As expected, the unemployment rate fell from 4.3% to 4.2%, while the rise in hourly wages was a little stronger than anticipated.
These three central elements in the job report, which are typically those that trigger market reactions, sent contradictory messages. In addition, the sharp drop in the number of jobs created in the private sector revealed in the preceding ADP survey had probably led many investors to steel themselves for a net job creations figure even lower than the number that was published.
Other elements of the report may have been considered negative, but economists are not unanimous. The BLS data, and other indicators, provide evidence to support various points of view. All agree, however, that hiring is slowing. The difficulty in assessing the exact pace of this slowdown illustrates the complex issues officials at the Fed face.
The message is a bit blurred
In his Jackson Hole speech on 23 August, Fed Chair Jerome Powell had warned that the Fed is not ‘seeking further cooling in labour market conditions and would not welcome such a move’.
In an interview published on 4 September, San Francisco Fed President Mary Daly reiterated the need to ‘protect’ labour market health (and avoid ‘overtightening’ monetary policy) while saying that ‘so far, though, the labour market has softened but is still healthy’.
Two key FOMC policymakers who spoke after publication of the employment figures said nothing to dispel the ambiguity around the size of the forthcoming rate cut (25bp or 50bp).
John Williams, New York Fed President, said he was not ready to say by how much policy rates should fall this month, while Fed Governor Christian Waller believed ‘it is important to start cutting rates in September’ and that he will be “an advocate of front-loading rate cuts if that is appropriate”, i.e. if subsequent data show ‘a significant deterioration in the labour market’.
We can conclude that being data-dependent is hard for policymakers when the data is inconclusive.
In the run up to their monetary policy meeting on 18 September, Fed officials will have little opportunity to get clarity on the situation and make sure that this highly anticipated rate cut does not lead to extreme reactions in the markets.
Volatility of expectations
In an initial reaction, futures markets see the latest employment report as reflecting a cooling labour market that would justify a 50bp cut, with the implied probability of such a move rising to above 50% right after the release of the data. That is up from 30% a week earlier, but the market then reacted to policymaker comments, causing the probability assigned to a 50bp rate cut to end the day at 29%.
The release of consumer and producer price indices on 11 and 12 September is likely to be another source of volatility. Given the current jitters, it is not certain that data confirming the recent trend towards lower inflation will allow expectations of a cut in key interest rates to stabilise. Investors have understood one thing well: Economic activity, not inflation, will determine the pace of easing.
The Bank of Canada may have found the right way to express this idea.
Commenting on its third consecutive 25bp rate cut, the BoC said the decision was based on two main considerations. “First, headline and core inflation have continued to ease as expected; second, as inflation gets closer to target, we want to see economic growth pick up to absorb the slack in the economy, so inflation returns sustainably to the 2% target”.
The central bank’s governor clarified that he was considering further rate cuts and that scenarios that would justify 50bp cuts were being discussed.
While the economic situation in the two countries is similar, the Fed may wish to draw inspiration from the BoC. Speaking of the risk of monetary policy becoming too restrictive because real rates will mechanically rise as inflation falls, San Francisco Fed President Mary Daly expressed the same idea of the need to support growth and, perhaps, showed the way ahead.
Life is simpler in Frankfurt than in Washington
Having cut key rates in June, against the views of some members, the European Central Bank (ECB) does not face the same questions about the pace to be adopted.
A 25bp cut is almost fully anticipated from the policy meeting on 12 September. The voices of the hawks are less audible with the pace of inflation and wage gains having slowed.
Fed policymakers will likely draw comfort from the fact that expectations for the ECB’s decision in December have been volatile.
