US payrolls surge

US payrolls surge as Fed meeting set to be hawkish

US payrolls grew by a healthy and robust 272k last month, well above the 180k expected. Private payrolls helped the surge, rising by 229k higher than the 165k expected. The payrolls figure was a shock to the market, the highest economist estimate ahead of the report was 258k. The immediate reaction has been an uptick in the dollar, EUR/USD has fallen nearly 70 pips, and the chance of a September rate cut from the Fed has fallen back to 50% from 60% before the report. However, does the uptick in the unemployment rate to 4% complicate the outlook for the US labour market?

No signs of weakness in the US labour market   

The Bureau of Labor Statistics in the US said that although the unemployment rate ticked up to 4% last month, overall the number of employed people and the unemployment rate had changed little over the past month and thus does not indicate an uptrend in US unemployment levels. Instead, the payrolls growth is what is most astounding about this report. NFP growth at 272k was above the average monthly gain over the past 12 months of 232k. The biggest job gains were in healthcare, government, leisure and hospitality and professional, scientific and technical services. This is fairly broad based and suggests that after a dip at the start of Q2,             the US economy is back firing on all cylinders.

US economy picks up after early Q2 dip

This is not the only sign that the US economy’s dip in April was a mere blip, and not the start of a prolonged downtrend. The Atlanta Fed’s GDPNow estimate of Q2 GDP also rose to 2.6% this week, up from 1.8% last week. This estimate was boosted by a stronger than expected ISM Service sector report for May, which rose to 53.8 from 49.4 in April. Services are the mainstay of the US economy, and a strong ISM reading combined with strong jobs growth in this sector suggests that it is in robust health.

What the payrolls report means for the Fed meeting

The timing of the jobs report is important since it comes ahead of next Wednesday’s FOMC meeting. The Fed is not expected to adjust policy at this meeting, but they are expected to signal if and when a cut could be coming, and to give their latest Dot Plot, which could reduce the number of rate cuts FOMC members are expecting in the coming years. Thus, the weight of today’s labour market report falls heavily on the market. 2-year US Treasury yields are up 13 basis points in the aftermath of the report and the spread between US and German 2-year yields has also widened slightly. The narrowing of this spread was an important driver of the strength of the euro vs. the USD in recent weeks. Thus, we could see EUR/USD fall towards the low end of its range at $1.0800 ahead of the Fed meeting.

A hawkish shift in the Dot Plot now expected

The market is now pricing in just one interest rate cut for the US in 2024, the Fed’s previous Dot Plot was expecting 3 rate cuts this year. Thus, we could see the Fed’s view move towards the market’s view on Wednesday. If this happens, and FOMC members revise down their expectations for rate cuts to just 1 for this year, then the market reaction could be fairly stable, afterall, that scenario is already priced in by the market. There is a small risk that they could rule out rate cuts for this year completely due to the strength of the labour market. If this happens then it would be a major hawkish development and it could trigger a surge in bond yields, broad based dollar strength and weakness for equities.

Equities to struggle after reaching record highs

We believe that equities will struggle into next week’s FOMC meeting. European stocks have extended losses in the aftermath of the payrolls report, and US stock index futures have turned lower. The surge in US Treasury yields could hurt the outlook for US big tech firms, which tend to rise when Treasuries fall.

NFP’s puts a spanner in the works for the meme stock craze

Today’s labour market report is also weighing on the meme stock craze. GameStop surged nearly 50% on Thursday, however, it is currently down 20% in pre-market trading. The prospect of higher for longer interest rates, a terrible earnings report and news that GameStop management have decided to issue 75mn new shares, are weighing on the stock. It is also worth noting that GameStop has completely diverged from fundamentals. Its 12 month forward P/E ratio is now 2,327 times earnings. Perhaps investors are waking up to reality?