Labor market data and rate cut expectations weigh on US Dollar

The Federal Reserve has stayed on course with its plan of delivering its tenth consecutive rate hike, as predicted, however, the emphasis on incoming data has been increased with its new guidance. The upcoming nonfarm payrolls on Friday (today) at 12:30 GMT will prove to be the next challenge for the US dollar, with forecasts pointing to a discouraging outcome. The Federal Open Market Committee (FOMC) has opted to increase its funds rate by a quarter percentage point to the highest range in sixteen years of 5.0-5.25% to curb inflation, despite the recent collapse of three private banks. Powell confirmed the banking system to be sound and resilient, but acknowledged the increasing downside risks in the sector and a possible need for a more cautious approach.

Upcoming nonfarm payrolls report may show slowdown in job growth

As investors eagerly await the release of the April nonfarm payrolls report on Friday, the Federal Reserve's new guidance has heightened the report's significance. While the data is expected to show a slowdown in hiring compared to previous months, it's important to note that the pace of job growth remains faster than what would be considered neutral for the labor market. However, certain industries are experiencing worker shortages, which has helped to keep pockets of the labor market tight. Nevertheless, the impact of Fed rate hikes and recent stress in the banking sector may put a damper on hiring in the months ahead.

Investors are bracing themselves for a possible disappointment as April's nonfarm payrolls report is projected to show a slowdown in employment growth to a more-than-a-year low of 180k. The unemployment rate is expected to tick up negligibly to 3.6%, while wage growth remains steady at 4.2% year-on-year. Despite the current robustness in nonfarm payrolls, historical patterns suggest that a recession beginning in July could lead to a sharp rise in job losses in the second half of 2023. However, some analysts believe the risks are skewed to the upside, particularly after the ADP report blew away expectations, estimating a 296k rise in private payrolls in April, nearly double the consensus estimate of 150k.

concerns are growing over potential headwinds to job growth. Specifically, the information sector has already experienced significant layoffs, and we anticipate that cooler hiring in professional and business services is on the horizon, as this industry is likely suffering from overhiring in the pandemic recovery. Additionally, the manufacturing sector is undergoing a recession that has been in motion for some time, leading to more layoffs in that area. However, despite these challenges, the education and health services industries face a shortage of workers, which should keep employers hiring and support the labor market in the short term. Data also suggests that the layoff rate will continue to trend upward, and the number of unemployed workers should begin to increase, as reflected in the uptrend in continued claims data.

Labor market data to impact USD as rate cut expectations persist

If forecasts hold true, the upcoming jobs data would still indicate a tight labor market. However, with futures markets pricing in persistent rate cuts, any significant dip in jobs growth could potentially send fresh negative shockwaves to the US dollar. This would be especially true if the participation rate also declines. Although Powell has tried to reassure investors that rate cuts are not currently on the table, his efforts appear to be in vain. Investors are still providing a small probability of 13.5% for a 25 basis point rate cut in June, while projecting an equivalent rate cut at some point in the fourth quarter.

Moreover, any monthly increase in hours worked could have a substantial impact on weekly compensation growth, pushing it above the level consistent with the Fed's 2% inflation target.