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US Reaction: Mixed Payrolls Keep November Fed Debate Open

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  • Payrolls rose by 263k, slowing from the previous month’s 315k, but still solid.
  • Household employment growth also slowed to 204k, the two measures moving more in alignment again.
  • Unemployment fell to 3.5% with a drop in labour supply in September. This followed a sharp rise in supply in August.
  • Earnings growth rose by 0.3% on the month, the second successive month with an annualized rate of 3.5%.
  • In total the report was mixed with no knock-out argument ahead of the Fed’s meeting in November.
  • For now we continue to forecast a 0.50% hike in November, but next week’s CPI inflation and movements in financial conditions before then will be critical to the Fed assessment.

The labour market sent rather mixed messages in September. Employment growth continued to soften and pay growth posted its second successive monthly increase at a pace the Fed would interpret as consistent with its inflation target.

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However, uncertainty over labour supply, with another drop this month resulting in a fall in unemployment back to 3.5% will continue to vex the Fed. Even allowing for the sharp 1m+ reduction in vacancies earlier in the week, the labour market is too tight and requires further tightening.

However, the Fed may judge that a large, rather than jumbo tightening (50bps rather than 75bps) may be in order. For now we stick with our view for the former, but next week’s inflation print and the evolution of financial conditions over this month will be critical to November’s call.

Slowdown In Payrolls Growth

Payrolls growth slowed further in September, although rising by 263k, a little above the 255k consensus, they still increased at a solid pace albeit below the 315k in August and upwardly revised 537k (+11k) in July.

A breakdown by sector showed outright falls in retail, transport and warehousing, which may reflect some of the cost-of-living pressure on household spending and the retail sectors. Employment in financial activities also fell. Elsewhere there was a softening in growth in professional and business and leisure and hospitality sectors.

The household measure of employment also slowed to 204k from 442k, the first time the household measure has been close to the payrolls measure for months. However, the unemployment rate fell unexpectedly to 3.5% from 3.7% (and the broader measure of underemployment dropped to 6.7% from 7.0%).

This was more directly impacted by labour supply, which fell marginally on the month again is September having posted a sharp 0.5% rise in August and saw the participation rate edge down to 62.3% from 62.4%. The behaviour of labour supply is perhaps the most confounding labour market issue.

Expectations For Improvement In Labour Supply

We continue to expect a modest improvement in labour supply over the coming months – penciling in something in line with the average Q3 rise of 0.15% per month over the rest of this year before slowing to 0.10% next year. This would see participation return to 63.0% by end-2023. However, there is marked uncertainty around the overall outlook and the month on month changes.

Average wages also rose by 0.3% on the month for the second consecutive month. The average annualised pay growth of the last two months is 3.5% and a pace that is consistent with the Fed achieving its inflation target.

However, over the year-to-date the annualized rate is a firmer 4.2%. Moreover, with the annual rate slipping back to 5.0%, the Federal Reserve will require several more months of this rate of pay before it can be sure of an easing of labour market pressures, even though this is softer than the 5.6% rate recorded in Mar.

Additionally, non-supervisory pay growth slowed further in September dropping to 5.8% from 6.7% in March.

On balance there is evidence of the labour market beginning to soften. Slower employment growth on both measures and an easing in monthly pay pressures suggest a softening in labour market demand.

For sure they are still solid for now, but combined with evidence that vacancies fell back sharply in August they suggest that the Fed may not need to tighten by another jumbo 0.75% at its next meeting in November. However, persistent uncertainty surrounding labour supply will continue to urge some caution with regards to gauging labour market tightness.

On the basis that the 3-monthly trend increase of 0.15% is encouraging and that monthly pay growth appears to have softened, we suggest that an argument can be made for slowing the pace of policy increase to just 0.50%. However, today’s mixed report provides few compelling arguments one way or the other.

We continue to expect a 0.50% increase in November, but will closely watch next week’s releases – including CPI inflation – and the evolution of financial conditions ahead of the Fed’s next meet.

In a volatile few weeks in markets, today’s release – close to consensus – provided little stir. At the short-end 2-year UST yields were 2bps higher, as was the expectation for end-year Fed Funds Rate.

However, the market priced a modestly lower (-2bps) peak in June 2023. 10-year yields rose by more, up 4bps to 3.87% and the dollar rose sharply up 0.7% initially before settling to +0.4%.