Institutions Declare September Nonfarm Payrolls "Killed" October Rate Hike Expectations! "New Fed News Agency": Jobs Report Does Not Change Fed's Stance, September CPI More Important

The September U.S. Non-Farm Payrolls report showed a significant cooling, causing market expectations for imminent rate hikes by the Federal Reserve to decline further. Data indicated that job growth was far below expectations, the unemployment rate rose slightly, and wage growth continued to slow. Following the report’s release, U.S. Treasury yields fell noticeably, U.S. stocks moved higher, and the rates market quickly pared bets on a Fed rate hike this month.

According to a report published by the U.S. Bureau of Labor Statistics (BLS) on Friday, non-farm payrolls in the U.S. increased by only 29,000 in September, well below market expectations of around 90,000. August job gains were revised down from 162,000 to 133,000, and July was revised from an increase of 21,000 to a decrease of 10,000. The combined revisions for July and August resulted in 60,000 fewer jobs. The unemployment rate for September rose to 4.2%, rather than holding steady at August’s 4.1% as expected by the market. Average hourly earnings in September rose 0.1% month-on-month and 3.0% year-on-year, both slower than in August, contrary to market expectations of holding steady at August’s 0.3% and 3.1% increases.

Nick Timiraos, a journalist known as the “new Fed wire service,” commented on the latest payroll report by noting that this week Fed officials have already signaled proactively that a rate hike in October is likely not their base case. He believes this report does not change that established stance. The most notable aspect, according to Timiraos, is that neither wages nor the unemployment rate indicate the labor market is tightening enough to meaningfully increase price pressures.

Timiraos believes, by contrast, that the September U.S. CPI released on October 14 will be more important. Still, this jobs report “does somewhat mitigate the hawkish shift in market expectations regarding the path of Fed hikes.”

Wall Street also noticeably leans towards “no hike in October.” Jefferies chief U.S. economist Tom Simons stated bluntly that this jobs report “should completely end talk of an October rate hike,” adding, “Previously we expected the Fed to continue with 25 basis point hikes each time, but the current situation suggests those policymakers emphasizing there’s plenty of time before the next hike are more likely to remain patient.”

Market pricing shows that, following the report, traders see the probability of an October Fed hike falling to around 20%, down from nearly 30% previously.

The Labor Market Has Not Retightened, Wall Street Leans Towards ‘Wait-and-See’ in October

From the data itself, while September saw only 29,000 new non-farm jobs—well below expectations—the report does not indicate the job market is experiencing a broad-based slowdown.

BLS data shows that over the past three months, non-farm payrolls increased by an average of about 51,000 per month, and over the past year, an average of 41,000 per month. The unemployment rate rose to 4.2%, but remains in the narrow range of 4.1% to 4.3% seen this year. Citing Christopher Hodge, chief U.S. economist at Natixis, Reuters noted that while the September jobs data is disappointing, it seems more like a continuation of existing trends than a sudden deterioration of the labor market; the three-month and one-year average job gains are still higher than the breakeven level that can stabilize the unemployment rate for most economies.

Meanwhile, wage growth continues to slow. In September, average hourly earnings rose just 0.1% month-on-month, with the past twelve months’ increase slowing to 3.0%. This is exactly what Timiraos emphasized as key: The report does not show that wage pressures are accelerating anew, nor that the unemployment rate is indicating a tightening labor market sufficient to stoke inflation in any obvious way.

Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management, said the “cooling” performance of the September jobs report makes a rate hike later this month less likely. She noted, “Today's softer data refute the view that the labor market is retightening.” However, she still considers a December hike as the base case; at the same time, continued market stress and further increases in energy prices could also force the Fed to act this month.

Vanguard senior economist Adam Schickling thinks the current labor market is exhibiting a “low hiring, low firing” state: hiring is weak, but layoffs remain extremely low, so future monthly jobs data may well continue to send mixed signals. In other words, the labor market is neither deteriorating significantly nor making a clear comeback, giving the Fed a reason to continue waiting for more data.

The Betting on an October Rate Hike Drops Suddenly, But December Is Not Off the Table

After the employment report, the rates market responded quickly.

According to Reuters, the probability of an October Fed rate hike priced by the market dropped at one point to 12%, later rebounding to around 21%. Bloomberg, citing swap market data, reported that traders see the probability of an October hike at about 20%, down from nearly 30% before the NFP report. At times, the market was no longer fully pricing in a Fed hike for the remainder of the year.

The yield on the 2-year U.S. Treasury note fell about 10 basis points at one point, then rebounded. This shows that the bond market quickly trimmed bets on a near-term rate hike, but has not completely ruled out the possibility of future Fed hikes.

Greg Taylor, Chief Investment Officer at PenderFund Capital Management, said this jobs report means the risk of an October rate hike has basically been taken off the table by the market, though a December hike remains in play. Stephen Kolano, CIO at Integrated Partners, believes the weaker-than-expected NFP will drive the Fed to “wait and watch inflation.”

Gary Schlossberg, Global Strategist at Wells Fargo Investment Institute, also believes the report significantly reduces the risk of an October hike, though the market still must keep an eye on the December meeting.

Market Repricing: October Rate Hike Odds Fall to Around 20%

Following the jobs report, the rates market responded quickly.

Bloomberg, citing interest rate swap market data, said traders’ pricing for a Fed rate hike in October fell from nearly 30% before the data release to about 20%. At certain points, the market was no longer fully pricing in a Fed hike this year. The 2-year U.S. Treasury yield fell about 10 basis points at one point, then partially rebounded, showing that while market expectations for a near-term rate hike have fallen visibly, the possibility of further Fed hikes has not been abandoned.

This stands in stark contrast to the previous hawkish repricing in the Treasury market.

In recent sessions, rising inflation pressures, energy prices, and economic resilience had led the market to reprice in more hawkish policy risk, driving Treasury yields higher. This jobs report, though, temporarily relieves that pressure: slower job growth, a higher unemployment rate, and a further cooling of wage growth mean the Fed has no need to rush into another rate hike purely out of fear of an overheating economy.

Charles Tan, Global Chief Investment Officer for Fixed Income at American Century Investments, said this report “marginally gives the Fed more room to stay on the sidelines,” but also cautions that the market could switch back to a more hawkish stance with just one or two inflation prints.

In other words, while market pricing for an October rate hike has faded markedly, the rate hike cycle itself has not been ended by this jobs report.

‘Bad News Is Good News’, But Wall Street Still Eyes 5% Treasury Yield

The Wall Street Journal characterized the market’s reaction as a classic case of "bad news is good news": slower economic and job growth reduces pressure on the Fed to keep tightening, thereby easing the recent burden of high Treasury yields and lifting stocks.

But some institutions caution that the market shouldn’t simply treat weak jobs data as unambiguously positive.

eToro analyst Bret Kenwell commented that if investors are merely hoping for a weaker labor market to get looser financial conditions, this is not a cost-free trade-off. Inflation remains an issue, and a genuinely faltering labor market brings very different risks.

Kenwell specifically pointed out that the 5% yield on the 10-year Treasury remains a key level to watch for the market. If 5% becomes the new floor for yields, then the logic that the market can keep absorbing higher rates without significant consequences will be challenged.

Edward Jones investment strategist Angelo Kourkafas thinks the softer jobs report should ease bond market fears of aggressive rate hikes; if the labor market stays broadly stable and corporate earnings keep growing, then the equity market fundamentals remain somewhat supported.

The October CPI Is the Next Key Test

Thus, the most direct impact of the September jobs report on the Fed is to markedly reduce the urgency for an October rate hike, not that the Fed has abandoned further rate hikes.

That’s exactly why Timiraos emphasizes the importance of the September CPI reading.

The September CPI, due October 14, will become the market’s next crucial datapoint to judge future Fed policy following Non-Farm Payrolls. If inflation remains sticky, especially with rising energy prices, then a soft jobs report may not be enough to keep the Fed from hiking again this year; conversely, if inflation also cools, a softer labor market will reinforce the case for Fed patience.

Judging from the current market pricing, the September jobs report has already materially weakened expectations for an October rate hike: bets on an October move have dropped to around 20%, and some on Wall Street think the report may have “killed” prospects for an October hike.

But, as Timiraos stresses, the jobs report has not changed the Fed’s basic stance – inflation still remains the key variable for the next step in policy.

Thus, market trading logic is shifting from “whether the Fed will soon hike again” to “whether the September CPI reignites rate hike expectations.” The inflation report on October 14 could decide the next phase of this policy expectation contest.