Curmi & Partners

US labour report dwindled Fed rate cut odds

By Nicole Busuttil

On Friday, 5th January, one of the most awaited and observed US data prints was published, the US labour market report, which showed that employers in the US hired more workers than expected during the month of December. The payroll employment posted a stronger-than-expected monthly gain of 216,000 jobs compared to the consensus forecast of 175,000 and the downwardly revised estimates for November of 173,000 and for October of 105,000 (showing a bigger impact from the October’s United Auto Workers’ strike). The increase in December was once again concentrated in only a few non-cyclical sectors, with government employment rising by 52,000 and health and social assistance employment up by 59,000, while in the cyclical sectors, leisure and hospitality employment was up by 40,000. The three-month moving average (“3mma”), which is the preferred gauge of the Federal Reserve, was at 165,000 per month in the last quarter of 2023. This was notably slower than the 3mma of 221,000 per month for the third quarter and the moving average of 257,000 per month for the first half of the year.

Meanwhile, average hourly earnings rose 0.4% month-on-month, in line with November’s elevated 0.4% month-on-month pace and above the expected 0.3% month-on-month consensus forecast. On a year-on-year basis, average hourly earnings rose 4.1%, compared to the prior 4% and the consensus forecast of 3.9%. On the household side, the unemployment rate held steady at 3.7%, below the market forecast of 3.8%, influenced by a slowdown in new entries into the labour force. With regards to the participation rate, this declined to 62.5% last month from 62.8% in November, pushed downwards by the decline in the workforce.   

The labour market’s slowing but steady pace during 2023, coupled with a sharp slowdown in inflation, has fuelled investor optimism that the economy can achieve a so-called soft landing. Prior to the release of the US labour report, money markets were pricing in a c. 90% chance of a rate cut from the Fed as soon as the March meeting. However, following the report, these odds fell to around 67% as the market saw the Fed as less likely to rush to cut rates as long as the US domestic economy continues to push towards stable growth and avert a recession. As a result of the sudden thumbling odds, the US Treasury 10-year yield rose to 4.063% and the two-year yield rose to 4.435%, major stock indexes rose very slightly, and the dollar index rallied. These odds may however still be overly optimistic. In fact, the Fed’s December meeting minutes released Wednesday 3rd January suggest that the FOMC members remain quite reluctant to reduce rates very soon.

The main argument for cuts remains the progress on inflation in recent months, and following the strong labour report, the December inflation print being reported on Thursday 11th January will attract even more attention. In fact, the minutes stated that, “the committee would need to see more evidence that inflation pressures were abating to be confident in a sustained return of inflation to 2%”. On a year-on-year basis, expectations are for the December headline inflation print to come in at 3.2%, slightly above the prior 3.1%, due to expectations that energy prices provided a modest boost during the month. On the other hand, expectations for the core inflation print are at 3.8%, down from the prior 4%. Moreover, the PPI print being released a day later is also expected to gain attention as this will help inform the estimate of the December PCE inflation, the FOMC’s favourite inflation measure. The headline PPI print for December is expected to rise to 1.3% year-on-year compared to the prior 0.9%, while the core print is expected to decline to 1.9% year-on-year compared to the prior 2%.

At present, activity in the US remains resilient, with the Atlanta Fed GDP tracker now signalling 2.5% (seasonally adjusted annual rate, “saar”) growth in the fourth quarter of 2023. Furthermore, the light vehicle sales data jumped from 15.3 million to 15.8 million saar in December, indicating resilient household spending. The robust momentum in economic activity and underlying inflation measures which continue to run above the pre-pandemic range suggest that conditions for a “sustained return of inflation” may not yet be in place. Therefore, it may be premature for the Fed to cut rates as from the March meeting. Based on current data signals, it is more likely that the Fed may cut rates just prior or during the second half of the year.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.