Jackson Hole leaves a hole heap of questions about employment

We now have a post-Jackson Hole set of questions – will the data stick up to what was preached. Reviewing the reactions to Jackson Hole treasury yields declined on a ramp up in bets around the Federal Funds rate after Federal Reserve Chair Jerome Powell’s dovish remarks, which were in line with what we forecasted last week.

His dovish remarks were enough to shift market expectations for the September Federal Open Market Committee (FOMC) meeting not just towards a potential rate cut, but to a possible heavier cut (50 basis points or more). Current market pricing for September is above 30 basis points suggesting it is keeping some of its powder dry ahead of the mid-September meeting. 

But it wasn’t the absolute nail in the hawkish view some were hoping. The current economic environment is making markets highly reactive. Every piece of data that could indicate whether the U.S. economy is heading for a “hard” or “soft” landing is being scrutinised. That is particularly evident post the softer employment data released in early August, and thus we traders still have plenty of volatility to play with in the coming weeks.

Jackson Hole in review

Chair Powell’s remarks at Jackson Hole signalled the shift in the Fed’s focus we all expected. But it is where the focus has shifted to that matters – the Board’s focus has shifted from inflation to labour market concerns. 

He emphasised that the Fed does not seek further cooling in labour market conditions and noted that the labour market is looser now than it was in 2019 when inflation was below 2%. 

While Powell did not specify the size of potential rate cuts, he indicated that the current policy rate gives the Fed ample room to respond to any risks, suggesting that rates are still far from neutral and could return to that level relatively quickly.

The market has taken this change in focus to pencil in the next most important date into its calendar – September 6. This is when the August employment data will be released, and it will be crucial in determining whether the Fed opts for a 25 basis point or a 50 basis point rate cut 10 or so days later. 

If the unemployment rate remains at 4.3% or rises further, comments suggesting that the labour market is “strong” would appear to be out of touch, and language like this sounds eerily similar to the previous underestimation of inflation being “transitory.”

So lets drill into what will be the biggest driver of FX and indices ahead of the September meeting – labour

The Labour Market the Key to all

In the coming weeks, the most critical economic data will revolve around the labour market, as its health will determine whether consumer spending and overall economic activity has remained strong. 

The Bureau of Labor Statistics recently estimated that payroll employment as of March 2024 is 818,000 lower than initially thought. Think about that for one second, that is the entire population of the Gold Coast and 80,000 more or to put into Australian numbers its 60,000 jobs less than originally suggested.

This has moved the average monthly figure down by 68,000 jobs for the period from April 2023 to March 2024 going from 247,000 a month to 179,000 a month. The Fed needs to average 200,000 for the economy to be running at neutral. Although these revisions are not finalised until February 2025, the significance is clear – the jobs market is not as strong as previously believed and suggests like we discussed last week that the US could be skidding into a recession based on the Sahms recession indicator. Which is when the three-month moving average of the national unemployment rate is 0.5 percentage point or more above its low over the prior twelve months. This was triggered in early August and we saw what that led to.

What has also caught traders off guard is that historically, revisions to payrolls have been to the upside versus preliminary estimates, mainly due to delays in receiving more complete data from the Quarterly Census of Employment and Wages (QCEW). 

But when we look at periods of economic stress, take 2009 for example, the final estimates have sometimes shown even larger downward revisions than what we have seen this year. 

This trend might be due to the overestimation of factors like the birth-death adjustment and part-time to full-time payrolls, which could be happening again now. If 2024 estimates are indeed overstated, it suggests that July’s job growth was more likely to be 114,000 jobs, a figure that may not be confirmed until the next year’s benchmark revisions. But a massive USD risk whatever the final figure turns out to be.

We stated last week that despite USD dovish trading over the past few weeks. It’s far from overdone. And we see the labour force data for the rest of the year being key to possible further selling

Divergence Between Payroll Growth and Unemployment

That brings us to the growing divergence between strong payroll job growth and rising unemployment. We need to point out here this is not just a US phenomenon, Australia is seeing this situation as well, and it’s to do with the participation rate which is sneaking up. This means more people are falling back into the employment surveys suggesting unemployment might be higher than reported. So despite the robust employment growth figures – unemployment is on the rise faster than growth.

Housing Market

Switching to the other great indicator for the Fed and FX traders alike – housing. 

Existing home sales rose modestly in July, yet new home sales increased at a surprisingly strong pace – however thankfully they remain within recent ranges. 

Despite a recent decline in mortgage rates (see the 30-year rates as the benchmark here), there has been no significant uptick in new demand, with mortgage applications for purchases remaining low and higher-frequency sales indicators still soft.

Although not on the same level as the labour market for FX movements, signs of overconfidence, increased mortgage applications and existing home sales spikes would get the FOMC’s hawks crowing again. These members have suggested that there hasn’t been sufficient housing stress yet to signal a hard sustained cutting cycle is imminent making housing data the contrarian trade indicator.

The conclusion

We retain the view that the USD is facing continued head winds, labour data is weakening, the economy is slowing to levels that suggest it could be flirting with recession and inflation is back in sight of the 2% handle.

There is also one other piece of information that allows us to retain our bearish view on the USD…

Don’t Fight the Fed! – if they want to cut, they will take the USD with it.