Fed’s employment crossroads

By Aaron Hill

A bright spotlight falls on Tuesday’s US November employment report, and it is arguably the dominant asset driver. This is due to comments from Fed Chair Jerome Powell last week, suggesting that the softening jobs market is the primary reason for rate cuts, and because we are receiving October and November data together in a single release.

The data also arrives at a time when markets and the Federal Reserve are at odds. Markets are expecting 57 bps of easing next year (a little more than two cuts), against the Fed’s projection of just one cut, per its latest SEP.

The Fed announced a 25-bp rate cut last week that brought the target range to 3.50-3.75% – its third consecutive reduction this year and a total of 175 bps since the central bank’s easing cycle began in late 2024.

The decision was far from unanimous. Alongside Fed Governor Stephen Miran opting for a 50-bp cut – as well as Kansas City Fed President Jeff Schmid and Chicago Fed President Austan Goolsbee opting to hold steady (a 9-3 vote) – there were four additional ‘dots’ (non-voting members) that opted for no change, delivering somewhat of a hawkish tilt.

While more members chose to keep rates steady, the SEP indicated that GDP will grow and unemployment will tick lower next year, and inflation will cool. With inflationary pressures easing, the jobs market weakening, and a new Fed Chair taking office next year, all these supporting policy easing.

Interestingly, Powell recently let slip that Fed economists believe payroll figures may be overstated by 60,000 per month. Given that expectations heading into the event suggest the US economy added 40,000 jobs (median), the economy may actually be losing positions. However, the estimate range is wide, sporting a low of -20,000 and a high of 110,000. Essentially, the markets lack a clear view.

Nevertheless, a negative number would likely deliver more bang for our buck as the estimate distribution shows only a handful of economists expecting this, therefore offering more surprise than a positive figure, which is what the majority of economists forecast. If the unemployment rate also ticks higher, it could exacerbate USD selling.

The question for many right now, is the pace of Fed easing next year. If the jobs data comes in lower than expected, investors could increase Fed rate-cut bets for March (currently 50/50 [-13 bps]), with April then fully priced for a -25 bp reduction, which, by extension, would likely weigh on the USD heading into the close of the year.

Conversely, a better-than-expected print could prompt money markets to align more with Fed projections, providing the USD a boost.

In the UK, we will receive the Bank of England’s final update on Thursday, with markets assigning a 90% probability that the BoE will lower the rate by 25 bps to 3.75% from 4.00%. The last meeting on 6 November observed the central bank vote 5-4 to keep the bank rate at 4.00% (compared to expectations of a 6-3 split).

Although a rate cut is firmly on the table, I think the markets may have got a bit ahead of themselves.

I believe MPC members Breeden, Dhingra, Ramsden and Taylor will, once again, vote to cut the bank rate by 25 bps. Similarly, Greene, Lombardelli, Mann and Pill are again expected to keep rates unchanged.

Key at this meeting, of course, is BoE Governor Andrew Bailey. At the last meeting, Bailey said that “upside risks to inflation have become less pressing since August”, and he thinks additional policy easing is likely if “disinflation becomes more clearly established in the period ahead.”

Given the previous dovish vote split, the BoE’s signal that inflation has peaked, and a deeply divided MPC, Bailey holds the decisive vote. And with the decision essentially relying on Bailey’s vote, a surprise hold could generate a sizeable move in the GBP to the upside.

As regards key economic data, inflation is beginning to turn over, though it remains elevated. The October UK headline YoY inflation eased to 3.6%, following three months stuck at 3.8%, with YoY core inflation also easing to 3.4%, from 3.5% in September.

Services inflation also cooled to 4.5% – the lowest since December 2024 – from 4.7%. This is what is holding the bank back from cutting rates, as GDP growth remains meagre and unemployment is rising.

We have UK October Jobs data out on Tuesday, and the November inflation report on Wednesday. If we see a sizeable miss in both reports, it will trigger GBP downside, as markets price in more easing next year. A notable move higher in the data, nonetheless, could prompt a moderate hawkish repricing, providing a GBP bid, and may even change how BoE Governor Bailey votes. Time will tell.

Shortly after the BoE, the ECB’s decision will make the airwaves. However, this will be a ‘nothing burger’ event as the central bank has no reason to cut rates at this meeting, consequently leaving the deposit facility rate at 2.00% and the refinancing rate at 2.15% – the mid-point of the ECB’s neutral range.

ECB President Christine Lagarde is likely to reiterate that policy is in a ‘good place’, and note that they are not pre-committing to a particular rate path.

We round off this busy week with an update from the Bank of Japan, widely expected to increase its policy rate by 25 bps to 0.75%. Investors currently assign a 75% probability that the central bank will raise rates, a notable hawkish repricing from below 50% over the last month.

This was on the back of comments from BoJ Governor Kazuo Ueda at the beginning of this month, who, in ‘central bank communication’, basically telegraphed the move.

Ueda stated that the BoJ would consider ‘the pros and cons’ of increasing interest rates. This is bolstered by reports that BoJ officials will not attempt to oppose a rate increase at the upcoming meeting.

With inflation at 3.0% in Japan at the headline YoY level, and core inflation running at around the same rate, the question is whether the BoJ is falling behind the curve – I think they are – and what comes next?

Even with a rate hike to 0.75%, real interest rates remain in negative territory; therefore, we will see subsequent rate increases next year, with markets pricing in nearly two hikes (+43 bps).

The goal is to bring the policy rate to ‘neutral’ (currently estimated between 1.0% and 2.5%), a level that neither stimulates nor slows down the economy. The current rate is lower than this range, meaning several hikes are likely expected before the cycle ends.

An overly cautious Ueda and suggesting another near-term hike is uncertain for now, for example, the initial JPY upside could be short-lived. On the other hand, commitments to hike soon would underpin a strong bid in the JPY.

Aaron Hill is Chief Market Analyst at FP Markets

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