Soft US employment report keeps a September interest rate cut very much in play

A soft employment report from the US which leaves the prospects of a first interest rate cut being delivered in September firmly on the table. While the headline payrolls number printed slightly above expectations (190k) at 206k, the now familiar pattern of downwards revisions to past numbers was seen once again, with May's report revised lower by -54k. The private payrolls number, in the meantime, came in below expectations (160k) at just 136k, and also saw the May number revised lower by -36k. Overall the report is being seen as offering further, clear, evidence that the US labour market is slowing, prompting yields to move lower across the curve.

A breakdown of the numbers shows that the headline payrolls number was boosted by a large increase in government positions of +70k, a theme that has been seen in previous months and is starting to suggest some element of consistency. The private payrolls number itself was also boosted by private education and private healthcare positions, which if excluded leave an increase of just +54k. The clear picture being painted is that the numbers being seen are not suggestive of a broad-based increase in jobs, but rather are the result of increased hiring in specific sectors only and which have no real read-across to the underlying strength of the labour market.

The suggestion of this softer underlying picture is given added weight by the fact that the increasingly frequent pattern of downward revisions made to the payrolls numbers means that the average monthly revised reading is now 24k below the initial estimate. This means that today’s numbers are similarly likely to be revised lower over the course of the next two months. The worry that the headline payrolls report has been suggesting an overly strong labour market was alluded to at the last FOMC meeting, when some Committee members suggested that the official BLS survey may have been overstating actual job gains; the size of today's revisions suggests their fears were well-founded.

Going forward, the outlook for the labour market continues to look difficult and a further slowdown in the payrolls numbers can probably be expected. Survey data is continuing to show hiring intentions to be slowing, while the underlying trend in the initial jobless claims numbers is clearly upwards. Alongside both these things, job openings have returned to pre-covid levels while worries that unemployment will rise further is increasingly being expressed in household surveys. Accordingly, it is easy to see payrolls numbers dropping further over the summer months and a run of sub-100 private payrolls numbers being seen as we head into the Autumn and beyond looks increasingly likely.

The numbers were accompanied by a rise in the headline rate of unemployment to 4.1% from 4.0%, which means the average growth in employment over the last three months has now slowed to its slowest pace since the start of 2021. Average hourly earnings (AHE), in contrast, fell from 0.4% to 0.29%, suggesting that last month’s higher number was simply the unwinding of calendar effects that artificially suppressed April’s figure; it suggests that earnings growth has now returned to its underlying slowing trend. Although the AHE number takes the annual pace of growth to 3.9%, on a three-month-on-three-month basis, AHE fell from 3.6% to 3.5%, its lowest rate of increase for some three years and bringing earnings growth in line with the Fed’s 2% CPI target once productivity growth is taken into account.

Overall, taking all these things together, it is hard not to conclude that we are now seeing material evidence that the US labour market is slowing. And when viewed in light of the recent moderation seen in the inflation numbers, the Fed’s perception of the balance of risks, as the labour market slows and inflation eases, must surely be shifting also. The chances of a first interest rate cut being delivered in September have risen on the back of today's numbers, the market now showing around a 79% chance of a cut being delivered. If next week's CPI numbers show inflationary pressures also continuing to soften, expect this number to move close to 100%.