"Gambling on interest rate cuts" meets Non-Farm Payrolls night, the market needs a reason to continue "outrunning the Fed"

With signs of inflation and a cooling job market, market expectations for interest rate cuts have risen sharply recently, and global assets are dancing wildly. Is this the prelude to a big carnival or a mirage? Tonight, we will have a "crucial verification".

At 21:30 on Friday, December 9th, the US non-farm payroll report for November will be released. Economists generally expect the labor market to continue cooling: new job additions will rebound from the previous month, the unemployment rate will remain stable, wage inflation will slow down slightly year-on-year, and labor force participation rate will remain unchanged:

The number of new non-farm jobs is expected to reach 185,000, with strikes expected to bring an increase of 40,000;

The unemployment rate will remain the same as the previous month, at 3.9%, and the labor force participation rate will remain at 62.7%;

Hourly wage growth will slow down from 4.1% year-on-year last month to 4%, and increase from 0.2% month-on-month to 0.3%.

It should be noted that the re-acceleration of employment growth is mainly due to the return of Hollywood and automotive industry workers after strikes. Excluding this factor, overall employment growth has slowed down. In the past three months, the average number of employed people has increased by 204,000, much lower than the 342,000 in the same period last year. However, the unemployment rate has only risen by 0.2 percentage points in the past 12 months, reaching 3.9%, which is higher than earlier this year and still a sign of a strong economy.

Major investment banks still have huge differences in their forecasts for the number of new non-farm jobs in November. The lowest forecast among 20 large investment banks, including Morgan Stanley, is 130,000, and the highest forecast is 238,000 by Goldman Sachs. The expected values for the unemployment rate and hourly wage growth are not significantly different. Specifically:

Josh Schiffrin, Head of Macro Trading Strategy at Goldman Sachs, pointed out that the non-farm payroll report on Friday is a very important data for the global market, and all parts of the report are important (new job additions, unemployment rate, and wages), with particular attention to the unemployment rate:

If the report is strong, the recent market trend will reverse, reducing concerns about economic slowdown, and the market may reprice the probability of an interest rate cut in March to 50%.

If the report is overall weak, the market may continue its recent trend and may even start considering the possibility of a 50 basis point interest rate cut by the Federal Reserve in January or March.

Employment growth re-accelerates, but the return of striking workers is the main reason

The median forecast by economists shows that the US added 185,000 new non-farm jobs in November, an acceleration from the 150,000 in October. However, if we consider the 41,300 growth brought by the end of strikes in the automotive and Hollywood industries, employment growth in November is expected to slow down.

Among them, employment in the manufacturing industry may be weaker, and the construction industry faces some pressure in terms of employment. The growth rate in the retail and leisure industries is starting to slow down, and the previously released ADP report showed a decline in employment in the leisure and hotel industry for the first time in three years.In specific, a series of labor data released recently has shown signs of a slowdown in the labor market:

• The number of initial jobless claims for the week ending November 25th has increased, and the number of continuing jobless claims has reached the highest level in about two years, as indicated by the data on unemployment insurance claims, which is consistent with the non-farm data.
• Although the "small non-farm" ADP and non-farm data have contradicted each other in recent months, the ADP data for November once again fell short of expectations, and wage growth hit a new low in over two years.
• The employment index of the S&P Manufacturing PMI has declined for the second consecutive month, and the growth rate of the service PMI has hit its weakest level since October 2022. The employment numbers in the ISM Manufacturing PMI have also dropped significantly.
• Regarding the non-farm report for November, Nomura Securities pointed out that non-farm growth may show signs of slowing down, as business survey employment indicators have declined and the situation of applying for unemployment benefits also indicates a slowdown in hiring. However, driven by the return of striking auto workers and actors, employment growth in November is expected to accelerate to 195,000, with the strike factor expected to contribute an additional 40,000 jobs.

It is worth mentioning that Goldman Sachs, one of the most optimistic investment banks, expects that non-farm employment will increase by 238,000 in November, far exceeding general expectations. The return of striking auto workers and Hollywood workers may contribute up to 38,000 jobs. (Striking workers are counted as employed in household surveys, so their return to work will not affect the calculation of the unemployment rate).

Unemployment rate expected to remain unchanged at 4.0%, triggering the "Sahm Rule"

The unemployment rate, which is a measure of economic recession, is also worth paying attention to. Economists generally expect the unemployment rate to be between 3.9% and 4.0%. If the unemployment rate reaches 4.0%, it will trigger the "Sahm Rule," indicating that the economy is entering a recession.

The Sahm Rule states that when the three-month average unemployment rate rises 0.5 percentage points from the low point of the previous 12 months, the economy is in a recession. The low point of the unemployment rate in April this year was 3.4%, and the unemployment rates in September and October were 3.8% and 3.9% respectively. If the unemployment rate in November is 4.0%, it means that the three-month average unemployment rate is 3.9%, thus triggering an economic recession.

It is worth mentioning that in recent months, labor demand has shown signs of slowing down, and the short-term unemployment rate seems to have slightly increased. The JOLTs job openings have seen a decrease of 6.6%, and the number of people finding jobs (based on household surveys) has declined. The average duration of unemployment has increased, the number of people applying for unemployment benefits has risen from recent lows, and at the same time, the number of layoffs has gradually increased.In addition, from the crucial perspective of wages, the growth rate of salaries has continued to slow down, with average hourly wages increasing by 0.3% MoM and 4% YoY, but significantly lower than the peak of 5.9% in March 2022.

It is worth mentioning that sustainable wage growth is crucial for reducing inflation rates, so any significant changes may trigger market reactions. When trying to measure the supply and demand relationship, prices may be the most accurate method, and the significant slowdown in wage growth indicates that the supply and demand relationship is returning to normal.

When will the Fed cut interest rates?

Pricing of swap contracts indicates that the market currently expects the Fed to cut interest rates by at least a total of 125 basis points over the next 12 months.

Some Fed observers believe that the Fed's monetary policy meeting next week will keep interest rates unchanged, and the next step will be to cut interest rates. Some people believe that Fed officials are not strongly opposed to expectations of easing next year, as this is consistent with their belief that policy will eventually move towards easing.

However, Charlie Ripley, Senior Investment Strategist at Allianz Investment Management, warned:

The Fed's actions will still depend on the actual data they see, rather than following a predetermined path. This means that if the data does not support the Fed's reasons for easing policy, traders' predictions of multiple rate cuts by the Fed next year cannot be guaranteed to materialize.

From the development of the labor market, we have seen some signs of slowing down, but it may not have reached the level that the Fed hopes to see. The biggest risk on the horizon is the continued rise in wage pressures and the ongoing tightening of the labor market.

Nomura pointed out that if non-farm payrolls meet expectations, it may support the recent dovish turn by the Fed. The moderate labor market suggests that the current policy interest rate level may have sufficient restrictiveness, and higher unemployment rates and stable wage growth indicate some relief from inflationary pressures. Although the labor market has not experienced a significant downturn, the continued moderation leaves room for officials to consider starting rate cuts next year.

Goldman Sachs, which is quite optimistic about the labor market, based on the assumption of a "soft landing," expects the first rate cut to occur in the fourth quarter of 2024. By then, the Fed will cut rates once per quarter, by 25 basis points each time, until the second quarter of 2026, when the Fed funds rate will eventually reach 3.5%-3.75%, higher than the neutral rate of the previous cycle.

How will the market perform? Exceeding expectations and upward revisions from the previous month are the most dangerous

For US stocks, both overly strong and overly weak data are disasters, as Goldman Sachs pointed out in its report:

250,000: S&P 500 falls by at least 50 points

200,000-250,000: S&P 500 falls by 25-50 points

150,000-200,000: S&P 500 falls/rises by 25 points

50,000-150,000: S&P rebounds by 100 points

<50,000: S&P drops by 50 points

Standard Chartered Bank analyst Steven Englander added:

From a market perspective, the most dangerous outcome is if the new job additions exceed 210,000 and the previous month's data is revised upwards (with a 20% probability). This will force the market to reassess the pace of the US economic slowdown and the pace of Fed rate cuts. Before the FOMC meeting on January 31st, there will be another non-farm payroll data release, which is unlikely to be bad enough to warrant a rate cut in January or March meetings. In addition, if the data released in January is also strong, the market is likely to price in a slight rate hike in March.

In summary, "bad news" in the economy is also "bad news" for the market, whether it's a 4% unemployment rate (US recession) or significantly abnormal job additions (above 250,000/below 50,000). US stocks may suffer, and US bonds, gold, and even Bitcoin will face critical tests.