Payrolls Preview: Too Hot Or Too Cold Will Spook Markets

In a week which saw the latest Middle-East war escalate to unprecedented proportions, and a once in a generation port strike start, and seemingly end, it's not hard to see why tomorrow's jobs report may be a bit of a letdown, especially since the Fed has already committed to cutting rates. That's not the only reason why tomorrow's print may be a non-event: according to consensus, 150k nonfarm payrolls will have been added to the US economy in September, a similar pace to August’s 142k. While analyst forecasts range from 70-220k, it is unlikely that we will get an outlier print. The unemployment rate is also seen unchanged at 4.2%, beneath the Fed's year-end median projection of 4.4%. Wages are expected to grow 0.3% M/M, cooling from August’s 0.4% rate, while the annual measure is seen unchanged at 3.8% Y/Y.

Meanwhile, as detailed further below, labor market proxies released in the month have been mixed: weekly jobless claims data that coincides with the BLS survey week saw initial claims fall, while continued claims rose. Challenger layoffs eased slightly while ADP’s measure of private payrolls was above expectations. This was offset by the ISM manufacturing employment component which slipped further into contractionary territory, while the services employment entered contractionary territory for the first time since June. The lagging August JOLTS data was above expectations.

The September jobs data will help shape expectations of Fed easing through the end of this year; Chair Powell this week signaled a further 50bps of rate reductions via two 25bps rate cuts in November and December, a hawkish take compared to what the market is pricing in. This guidance and the hot ADP print has seen money market pricing tilt back towards a 25bps move in November, currently pricing a 64% probability of a 25bp cut in November. Nonetheless, if the data were to show a significant weakening (Fed's Bostic said a sub-100k print would warrant closer questioning), expectations for another 50bps move may become reinvigorated. That said, before the Fed’s meeting, there is still another jobs report due, which will give policymakers more data to assess in their deliberations.

Ultimately, as Goldman Delta One trader Rich Privorotsky writes today, the NFP tomorrow is obviously important but might actually take a back seat into the weekend. Payrolls should be straightforward in the sense that good news is good news and bad is bad news. "A print sub 100k will raise concerns of the Fed being behind the curve again (rates might trade better but think the soft landing that is priced into equities gets challenged).  The sweet spot is slightly better than expected (but not too strong ie <200k)."

Below we expand on these points, starting with what Wall Street expects tomorrow courtesy of Newsquawk:

• The BLS is expected to report 150k nonfarm payrolls added in September (prev. 142k in August; vs 3-mth average of 116k, 6-mth of 164k, and 12-mth of 197k). Forecasts among analysts are varied however, ranging from 70k-220k.
  • Private payrolls are seen rising by 125k from the prior 118k, while manufacturing payrolls are expected to show a decline of 5k (prev. -24k).
  • Goldman's analysts estimate payrolls rose by an above-consensus 165k in September, led by a private payrolls increase of 145k, also above consensus of +125k. The bank argues that big data indicators generally indicate  a solid pace of job growth, and seasonal distortions likely weighed on the last two payrolls readings.

• The unemployment rate is expected to remain unchanged at 4.2% (forecast range: 4.1-4.3%. According to Goldman two factors will weight on unemployment in September. First, the return of the youth labor force to school is likely to weigh on unemployment. 45% of the increase in unemployment since the cycle low has come from workers aged 16-24, and the lack of labor market opportunities could encourage them to exit the labor force at a greater rate than is seasonally typical. Second, temporary layoffs declined in August after spiking in July—likely partly reflecting the reopening of auto plants after summer retooling shutdowns—but remained about 60k above the June level, suggesting scope for further declines in temporary layoffs this month. Going forward, Goldman thinks it is a close call whether labor demand will prove strong enough to fully absorb new entrants to the labor market and halt the slow crawl higher in the unemployment rate that has taken place since mid-2023.
  • The FOMC’s recent economic projections have penciled in the jobless rate rising to 4.4% by the end of this year).
• Average hourly earnings are expected to rise +0.3% M/M in September (range: 0.2-0.4%), easing from the prior 0.4%
  • The annual rate is seen unchanged at +3.8% Y/Y (range: 3.7-3.9%). Wage metrics will be closely watched for signs of any renewed inflationary pressures which could derail the Fed's earnings cycle.

RECENT DATA:

As noted above, ahead of the September payrolls report, other labor market proxies have been mixed. Initial jobless claims were below expectations, continuing claims rose, the ADP’s gauge of payrolls topped expectations, Challenger layoffs eased from the prior month, while the ISM Manufacturing employment sub-index slipped further into contractionary territory, and the services employment fell into contractionary territory. Meanwhile, August’s JOLTS data (the most recent) came in above expectations.

• Weekly Jobless Claims data that coincides with the usual BLS survey week, saw initial claims fall to 222k from 231k, however Pantheon Macroeconomics suggested the fall was likely due to a defective seasonal adjustment, rather than a sudden improvement in labor market conditions; continuing claims for the reference week rose to 1.834mln from 1.821mln.
• The latest ADP data was hotter than all analyst forecasts, rising by 143k (exp.120k; the most optimistic forecast was for 140k), accelerating from the prior (revised up) 103k.
• The Manufacturing ISM Employment component slipped further into contractionary territory, falling to 43.9 from 46.0, with the report highlighting that "the July, August and September readings are among the five lowest recorded since the index registered 43.7 percent in July 2020, early in the economic recovery".
• The ISM Services PMI employment data fell to 48.1 from 50.2, falling into contractionary territory for the first time since June.
• Meanwhile, although it is data for August, the JOLTS data was hotter than expected, with job openings rising to 8.04mln from 7.711mln, despite expectations for a decline to 7.66mln; within the report, the quits rate fell to 1.9% from 2.0%, a level that Oxford Economics say is consistent with wage growth at or slowing to a pace consistent with the Fed's 2% inflation target.

ARGUING FOR A STRONGER-THAN-EXPECTED REPORT:

• Big data. Alternative measures of employment growth indicate a solid pace of job growth in September, with a median pace of +169k across the indicators we track (vs. +133k in August and compared to reported August job growth of +142k).

• Upward revisions to August payrolls growth. Nonfarm payrolls exhibit a tendency toward weak August first prints. This appears to reflect a recurring seasonal underperformance of the first vintage relative to the final vintage that causes initial readings to be revised higher in subsequent readings. Of course, payrolls revisions so far this year have been disproportionately negative — the next chart shows that two-month net revisions have averaged -35k so far this year — however August payroll growth has been revised up by 67k on average since 2010, about two thirds of which typically occurs in the first revision.

• Layoffs. Initial jobless claims declined to an average of 228k in the September payroll month from 236k in August, though some of the decline was driven by seasonal adjustment problems. The JOLTS layoff rate ticked down to 1.0% in August. Private sector employment typically declines on a not-seasonally-adjusted basis in September, suggesting that the low pace of layoffs could be a more important determinant of net job gains than in recent months.

ARGUING FOR A WEAKER-THAN-EXPECTED REPORT:

• Job availability. JOLTS job openings increased 0.3mn to 8.0mn in August but haven moved sideways-to-lower in recent months, matching the trend of alternative measures of job openings. The Conference Board labor differential—the difference between the percentage of respondents saying jobs are plentiful and those saying jobs are hard to get—declined by 3.3pt to +12.6 in September, further below the +30.4 average level of Q1 and the 2019 average of +33.2.

NEUTRAL/MIXED FACTORS

• Employer surveys. The employment components of business surveys increased on net but remained at contractionary levels in September. The employment component of Goldman's manufacturing survey tracker ticked down (-0.1pt to 46.8) while the employment component of our services survey tracker increased (+1.6pt to 49.5) in September. However, the signal from survey data has been less useful — and at times misleading—during the post-pandemic period and thus has little bearing on our payrolls forecast.
• A more moderate boost from catch-up hiring. Catch-up hiring in the health care and government sectors contributed 70k/month to aggregate payroll growth in 2023, according to Goldman. But with employment levels in health care and government approaching their pre-pandemic trends, the boost from catch-up hiring has slowed sharply to 30k/month in recent months. This boost will likely continue to fade and will be mostly complete by year-end, weighing modestly further on payroll growth.

FED IMPLICATIONS

At the September FOMC, the Fed adjusted its language to acknowledge that risks to the mandate are now "roughly balanced" (previously it said they continued to move into better balance), while also noting that job gains have "slowed" (prev. it described them as having "moderated"). It also added that the Committee is strongly committed to supporting maximum employment. Therefore, it is clear that the recent softness in the labor market is a concern for the Fed, and its September 50bps rate cut was to ensure policymakers get ahead of the curve, and act before the labour market falters. Fed Chair Powell this week explicitly signaled that, providing the economy evolves as expected, the Fed would ease by a further 50bps through year-end, with a 25bps cut in November, and a 25bps cut in December – pushing back against expectations for another 50bps reduction. This data will help shape easing expectations given the importance of the labor market to the Fed in the current climate. Fed's Bostic stated that if employment growth slows much below 100k jobs, it would warrant closer questioning of what is happening. If the data were to come in sub 100k, it would likely reignite bets for a 50bps rate cut, with money market pricing leaning more towards 25bps after Powell's commentary, and the hot ADP print on Wednesday.

MARKET REACTION

 

While Wall Street consensus is that, absent a major outlier print, the market reaction is likely to be subdued, there are nuances, and we start with the JPM market intel desk scenario analysis:

 

• Above 200k. This first tail-risk scenario would point to an economic reboot from a soft patch this summer. While ‘soft patch’ is not an appropriate description for an economy that is on-track to deliver real GDP growth north of 2.5%, we did see job growth slow; but, that now looks to be a temporary slowing. This type of print trigger a material re-pricing of bond yields higher and that spike in bond vol would likely spill over to Equity markets. While this is likely to produce a muted response on a 1-day basis, it would be a positive over time since higher NFP points to an even higher GDP growth trajectory which is also positive for earnings. This would, however, result in uncertainty over Fed policy; this type of print could see some investors thinking the Fed skips a cut in November. Odds 5%; S&P is flat to adds 50bps.
• Between 160k – 200k. This is our Goldilocks scenario since it would point to higher growth without an inflationary impulse. While bond yields would move higher, this type of outcome is aligned with a medium-term view that the combination of Fed easing, and lower energy prices will produce a tailwind to the economy that is likely to keep GDP growth above trend. This outcome would push the market to 25bps for November with even more uncertainty around 2025. Odds 30%; SPX adds 1% - 1.5%.
• Between 140k – 160k. This is the consensus print and still falls in the Goldilocks zone, where the economy continues to grow at a pace that supports earnings expectations without an inflation reboot. That said, this type of print is not enough to remove all concerns over recession eventually materializing. Odds 40%; S&P adds 75bps – 1.25%.
• Between 110k – 140k. A lower MoM print (previous NFP was 142k) would be a return to growth concerns and the potential resurfacing of the ‘Fed is behind the curve’ narrative. Look for bond yields to move lower and for Defensives to outperform in Equity space. Odds 20%; S&P falls 50bps – 1.5%.
• Below 110k. The second tail-risk scenario would be problematic for bulls since this could put the economic outlook towards one of a recession beginning in 24Q4. Typically, we see NFP print negatively just before a recession begins, so the closer to zero the worse the outcome. Here we would likely see an unwind of bullish Cyclicals/Value trades and for Credit to outperform Equities on the move lower. Odds 5%; S&P loses 1.25% - 2%.

Not surprisingly, the JPM Market Intel team is Tactically Bullish, and here's why:

We adhere to the formula of at/above trend GDP growth plus positive earnings growth and a supportive Fed continuing to drive the bull market. The economic environment is forming a tailwind to the consumer and corporate sectors, which we feel will continue this recent trend of elevated GDP growth. This is especially true if the Fed maintains its aggressive cut cycle as predicted by Mike Feroli; this will aid the Housing sector and eventually lead to a reboot of the Manufacturing sector. Also, we are of the view that the consumer remains on solid footing with the ability to continue to drive the economy as other segments of the economy are having a more muted impact.

That said, JPM concedes that a negative NFP print could shift the narrative to one of recession or stagflation, which would be negative for stocks.

Finally, we turn to Goldman trader John Flood who writes that Powell had a hawkish tone on Sept 30 as he noted that if the economy continues to unfold inline with current forecasts, there will be two 25bp cuts this year (this is exactly what the latest dot plot showed, but the fact Powell mentioned it has some investors preparing for 50bp of cuts over the remainder of  2024 instead of what the market is currently pricing in ~70bp). Flood also notes that "after the better than expected ADP print, whispers for tomorrow’s headline # have crept to 175k."

Curiously, Goldman's S&P’s reaction function to tomorrow’s headline print is rather different from JPM's in that it sees both a very weak and very strong print as negative.

• >200k: S&P sells off 0 - 50bps
•   150k – 200k: S&P rallies 100bps
•   100k – 150k: S&P + / - 50bps
• <100k: S&P sells off at least 100bps

Flood's bottom line: "Stocks want an inline(ish) print tomorrow. Too hot or too cold will accelerate risk off behavior into weekend (clearly cold is far worse)."

As an aside, the volatility market is pricing in a 115bp move for S&P through tomorrow's close.

Finally, going back to Rich Privorotsky, the Goldman Delta One trader looks at the possible bond market reaction and writes that the mood music on rates feels like it’s changing a bit: "maybe it’s the Druckenmiller comments or just the movement in oil. We are sitting just above a lot of cta triggers for bonds and if NFP confirms the us economy is doing just fine there could be some risk to a bigger repricing there. "

More in the Payrolls preview folder available to pro subs.