News & analysis

Since the Fed’s September meeting, which saw the median dot for this year remain at 5.625% and that for 2024 revised up by 50 basis points to 5.125%, markets have largely bought into the higher for longer narrative.

This has been reflected in the 48bp steepening in the Treasury curve. However, near-term pricing of the Fed’s policy path has been a notable exception to this trend. Before today’s payrolls release, markets were assigning less than a 40% probability of a Q4 rate hike. That is no longer the case after the US economy reportedly added 336k jobs in September, the largest net employment gain since January’s bumper 472k print and up from August’s upwardly revised 227k, even as average hourly earnings printed below expectations at 0.2% MoM, a rate that is sustained is consistent with the Fed’s 2% inflation target. Swap traders now view a final hike as a coin flip following today’s data, with the November hike specifically priced at 30%.

For FX markets, today’s monstrous payrolls print and the upwards revision to the August numbers once again highlights the difficulty in shorting the dollar in this macro environment. If it isn’t a haven bid due to risk sentiment taking a beating, it’s the US exceptionalism narrative supporting the greenback, which is now on track to record its twelfth successive week of gains.

Oh, can’t stop DXY now 

Employment gains concentrated in services 

The US economy added 336k jobs in September, considerably beating consensus expectations of 170k and the market whisper of 190k. For further context, the pace of job growth also exceeded the 12-month average of 267k and was the strongest month of job growth since January this year. Job growth was largely concentrated in services industries, with leisure and hospitality (+96k), health care (+41k), professional, scientific, and technical services (+29k) and social assistance (+25k) accounting for over half of the monthly job increases. This isn’t necessarily consistent with the signal from the recent services PMIs, which show activity and employment conditions steadily cooling in recent months. By comparison, transportation and warehousing was the only manufacturing-related sector that recorded job growth following the -25k drag in the month from the Truck strikes.

While the monstrous job gains reported in the establishment survey weren’t necessarily matched in the household survey, which saw the level of employment and the size of the labour force remain relatively unchanged to yield a stable unemployment rate of 3.8%, the sheer magnitude of the payrolls gains aren’t necessarily consistent with a US economy that is cooling and may produce fewer inflationary pressures, even if this is yet to become reflected in the wage figures.

With September’s payrolls tending to be revised up in the subsequent months, today’s data may be enough to tip the balance for the Fed to hike in November, even if next week’s inflation report continues to show inflation on track to return to 2% in the coming quarters as it underscores the upside risks to this disinflationary path stemming from a strong labour market.

Subject to confirmation in the growth data, r* must be higher than the Fed predicts 

Whisper it quietly, but today’s jobs report is awfully suggestive of a higher real interest rate in the US. Even if the Fed refuses to officially acknowledge it in their projections, the bond market is pricing it. 5-to-30-year Treasury yields rose 15 basis points following today’s jobs release, with the longer-term yields that are used to price mortgages in the US now sitting at their highest level since 2007. The post financial crisis records don’t stop there. Inflation adjusted yields, used to measure the effective tightness of monetary policy, have also risen to multi-decade highs. 2-year TIPS, for example, currently trade at 3.4%. This is placing pressure on equity valuations, even as a strong labour market data is suggestive with more resilient underlying growth conditions. The combination of weaker equities and higher yields is leading to a further tightening in effective financial conditions in the US.  In our view, this poses the biggest risk for a Q4 rate hike should the Fed deem the effective tightening of financial conditions as sufficient to ensure a soft landing outcome. If this is the case, policymakers may be hesitant to induce any overtightening with a further rate hike, although we note that the option to hold rates may well loosen financial conditions at an inopportune time.

This conundrum is reflected in rates markets, which now view the decision over a Q4 hike as finely split, although we do note that if a final hike is to occur, it is more likely next month than in December.



Simon Harvey, Head of FX Analysis

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