Friday's Jobs Report: Can Cooling Employment Stop the Fed's Rate Hike?

Original title: Week Ahead – US, 31 August–4 September: August Payrolls Is the Last Word Before the Fed's 16 September Decision
Original author: Capital Street FX Research Desk

Odaily News: On Sept. 4, the U.S. Bureau of Labor Statistics will release the August employment report. This is the last monthly nonfarm payrolls data before the Federal Reserve's Sept. 15–16 policy meeting, and a key window for assessing whether the U.S. labor market continues to cool.

July nonfarm payrolls unexpectedly fell by 23,000, and May and June figures were revised down by a combined 103,000, indicating that actual employment growth momentum was weaker than previously estimated. Meanwhile, U.S. inflation remains well above the 2% target, and after Fed Chair Powell's Jackson Hole speech, the market has priced in a higher probability of a September rate hike.

Capital Street FX believes that this week's core market tension has shifted from "whether the Fed remains hawkish" to whether slowing employment can offset inflationary pressures. JOLTS job openings, ADP employment, and ISM price and employment sub-indices will provide leading signals for Friday's nonfarm payrolls report, but what truly affects policy expectations may not be just the headline payrolls number, but also labor force participation, wage growth, and revisions to prior data.

The nonfarm payrolls report still cannot provide a final answer for September policy. The U.S. will release August PPI and CPI before the policy meeting, so more precisely, this report determines whether the employment-side evidence is sufficient to prevent a rate hike, while inflation data still holds the final say.

The following is a compiled translation of the original:

In the first week of September, the U.S. market will face a dense set of economic data: JOLTS job openings and ISM manufacturing index on Tuesday, ADP private employment and the Fed's Beige Book on Wednesday, ISM services index on Thursday, and the August nonfarm payrolls report on Friday.

These data will center on the same question: With inflation still elevated, has the U.S. job market weakened enough for the Fed to continue holding rates steady?

Currently, the market remains divided on the Fed's September policy path. In his Jackson Hole speech, Powell emphasized that if inflation does not clearly and quickly return to 2%, the Fed still needs to take further action. Market pricing cited by Capital Street FX shows that after the speech, the probability of a 25-basis-point rate hike in September rose from about 35% to 57%.

At the same time, interest rates and asset prices adjusted in tandem: the two-year Treasury yield rose 6.6 basis points to 4.29%, the dollar index gained 0.55%, and gold and bitcoin fell about 3.2% and 3.4%, respectively. These moves indicate that the market is repricing higher short-term rates into the dollar, precious metals, and crypto assets.

But whether this hawkish repricing can be sustained still depends on this week's employment data.

Nonfarm payrolls appear weak, but revisions send a stronger signal

July U.S. nonfarm payrolls fell by 23,000, significantly below the market's original expectation of an increase of about 83,000. Government employment fell by 53,000, while the private sector added 30,000. More significantly, May and June payroll gains were revised down by a combined 103,000, bringing the three-month average job growth down to about 20,000.

The U.S. Bureau of Labor Statistics has confirmed that the August employment report will be released at 8:30 a.m. Eastern Time on Sept. 4.

Looking at the unemployment rate, the July data appeared relatively strong: the unemployment rate fell to 4.1%, a 13-month low. But this improvement is partly related to the labor force participation rate dropping to 61.4%. In other words, the decline in the unemployment rate does not entirely reflect stronger labor demand; part of it is due to more people leaving the labor force.

Average hourly earnings growth also slowed to 3.2% year-over-year. If wage growth continues to decline, payrolls remain weak, and prior months' data are revised down again, the market may further reduce expectations for a September rate hike.

Capital Street FX therefore believes that the most important thing to watch on Friday may not be just the headline nonfarm payrolls number. Labor force participation, wage growth, and revisions to prior data better reflect underlying changes in the job market.

This judgment requires some caution. Monthly nonfarm payrolls data are volatile, and a single month of negative growth may be influenced by government sector, industry composition, and seasonal adjustments. Only when weak employment, slowing wages, and downward revisions occur together can they provide more complete evidence of sustained labor market cooling.

Three sets of data will provide clues for Friday's jobs report

Before Friday, the market will receive three sets of related indicators.

First, the July JOLTS job openings report on Tuesday. Job openings reflect unfilled labor demand by businesses; if openings continue to decline, it usually means labor market tightness is easing. However, JOLTS data are lagging, and a decline in openings does not necessarily mean companies are starting large-scale layoffs.

Wednesday's ADP employment report will provide private-sector hiring conditions. ADP and official nonfarm payrolls differ in survey scope and methodology, and their short-term trends can diverge significantly, so ADP should not be directly treated as a predictor of nonfarm payrolls. However, if the data are significantly above or below expectations, it may still affect market positioning in advance.

The ISM manufacturing and services indices released on Tuesday and Thursday provide clues on growth, employment, and inflation simultaneously. The July ISM manufacturing index was 55.6, the highest since May 2022; the employment sub-index rose to 52.8, re-entering expansion territory. The ISM services index was 54.1, but the employment sub-index was only 47.4, indicating that services activity is still expanding while hiring demand has contracted.

Compared with the headline indices, Capital Street FX pays more attention to the prices paid sub-index. The July ISM services prices paid index reached 70.3, indicating that corporate cost pressures remain strong. If this week's price sub-indices remain elevated, even if employment slows, the Fed will find it hard to completely ignore inflation risks.

The resulting combination may be more important than the nonfarm payrolls number itself: falling employment and easing price pressures would strengthen the case for a pause; resilient employment and elevated price sub-indices could solidify rate hike expectations; if both employment and prices weaken simultaneously, Treasury yields and the dollar could face more significant pullback pressure.

The core of market trading is how the Fed's "reaction function" changes

The so-called policy reaction function refers to how the market judges what policy actions the central bank will take under certain conditions based on variables such as economic growth, employment, and inflation.

Powell's Jackson Hole speech changed the market's short-term understanding of this reaction function. He emphasized that the 2% inflation target will not waver and argued that current financial conditions cannot yet be considered significantly tight. This led investors to reassess: as long as employment does not deteriorate rapidly, could the Fed still raise rates further to bring down inflation?

At the July policy meeting, the Fed voted 9 to 3 to keep the federal funds rate target range at 5.25% to 5.50%; three dissenters preferred a 25-basis-point hike. The meeting minutes also showed that the committee believes economic activity is still expanding steadily and inflation remains elevated relative to the 2% target.

Against this backdrop, the significance of the August nonfarm payrolls report is not to independently determine whether the Fed will hike rates, but to change the threshold of evidence needed for a hike.

If employment data are clearly weak, the Fed will face a clearer dual constraint: further rate hikes could accelerate job market cooling, but keeping rates unchanged could allow inflation to remain above target. Conversely, if employment continues to expand and wage growth remains resilient, policymakers will have more room to prioritize inflation.

Nonfarm payrolls may affect rate hike odds, but the final word still awaits CPI

The original article calls this week's employment report the "last word" before the September policy meeting, but this description needs to be downgraded.

According to the official schedule, the Fed will hold its policy meeting on Sept. 15–16; August PPI and CPI are scheduled for release on Sept. 10 and 11, respectively. Therefore, nonfarm payrolls are the last complete monthly employment report before the meeting, but not the last set of important economic data.

Three sets of verification signals can be observed next:

First, whether nonfarm payrolls continue to hover near zero growth or turn negative, and whether prior figures are revised down significantly again.

Second, whether labor force participation and wage growth weaken in tandem. If the decline in the unemployment rate still mainly comes from falling participation, the job market may not be as robust as it appears.

Third, whether the subsequent CPI release confirms easing price pressures. Even if nonfarm payrolls are weak, if core inflation surprises to the upside again, the market may still retain pricing for a rate hike.

For asset markets, weak employment data could push short-end Treasury yields and the dollar lower, providing breathing room for assets sensitive to real interest rates such as gold and bitcoin; strong employment combined with high inflation could push short-end rates higher. However, these are only market inferences based on current policy pricing, and actual reactions will depend on the deviation between data and expectations, as well as investors' prior positioning.

Therefore, the real question that Friday's nonfarm payrolls report will answer is not whether the Fed will definitely hike rates in September, but whether the job market has weakened enough to limit its room to hike. The final answer still depends on next week's inflation data.