Nonfarm Payrolls Preview Before Friday: How Will the Fed Choose Between Cooling Employment and Rising Inflation?

Original Title: US August Nonfarm Payrolls Preview: How Much Will It Impact the Fed's September Rate Hike Decision?
Original Author: Yulia Zeng, TradingKey

Editor’s Note: The U.S. Bureau of Labor Statistics will release the August nonfarm payroll report on September 4, which will be the last complete employment report before the Federal Reserve's meeting on September 15-16. The July nonfarm payroll unexpectedly decreased by 23,000, and the data for May and June was revised down by a total of 103,000; the latest ADP report shows that only 38,000 jobs were added in the U.S. private sector in August, further accumulating signals of hiring slowdown.

However, the policy environment facing this nonfarm report is different from the traditional "bad news is good news" scenario. Inflation remains above the Fed's long-term target of 2%, and rising energy prices and supply chain pressures have added new upside risks. In this context, weak employment may not directly lead to easing, but rather put the Fed in a dilemma of cooling growth and persistent inflation.

Yulia Zeng from TradingKey believes that what the market really hopes to see is not weaker employment, but rather a moderate cooling of hiring, a stable unemployment rate, and gradually easing wage pressures. Strong data may reinforce rate hike expectations, while weak data could trigger recession trades; an "orderly cooling" that falls between the two could provide a relatively friendly combination for risk assets.

Therefore, the August nonfarm payrolls are more like a piece of the puzzle for September's policy rather than a switch that solely determines whether to raise rates. Employment data will affect the urgency of the Fed's actions, while subsequently released inflation data may determine the policy direction. The market needs to simultaneously assess whether labor demand is slowly cooling or has already slipped into a more obvious economic contraction.

The U.S. Bureau of Labor Statistics will release the August nonfarm payroll report at 8:30 AM Eastern Time on September 4. According to the official schedule, this will be the last complete employment report before the Fed's meeting on September 15-16 and will also serve as an important basis for judging whether the labor market can withstand further rate hikes.

Predictions from different institutions vary slightly. The market expectation cited in the original text is for about 58,000 new jobs, with the unemployment rate remaining at 4.1%; the median forecast from the latest Reuters survey is about 56,000. Regardless of which set of figures is used, the market expects only a moderate rebound in August employment, significantly weaker than the expansion pace of the past few years.

The base is also relatively weak. The U.S. July nonfarm payroll unexpectedly decreased by 23,000, far below the market's previous expectation of an increase of 80,000; the data for May and June was also revised down by a total of 103,000. Although the unemployment rate fell from 4.2% to 4.1%, part of the reason is a decrease in labor participation, which cannot simply be interpreted as an improvement in the job market.

Before the nonfarm report is released, the ADP employment report further reinforced the impression of a hiring slowdown. In August, the U.S. private sector added 38,000 jobs, below market expectations and the lowest increase in seven months. However, ADP only covers the private sector, and its statistical methods differ from the official nonfarm data, making it more suitable as a reference for labor market trends rather than directly equating it with nonfarm predictions.

Adding 50,000 to 60,000 jobs may be the most acceptable outcome for the market

If the August nonfarm payroll adds about 50,000 to 60,000 jobs, it superficially indicates that the labor market continues to cool, but for the Fed, this result may not be sufficient to support an immediate shift to easing policy.

On one hand, if employment only slightly rebounds after a negative growth in July, it indicates that companies' willingness to hire is indeed weakening. On the other hand, job vacancy and layoff data have not yet shown simultaneous deterioration, with the labor market closer to a "low hiring, low firing" state: companies are not in a hurry to expand their workforce and are not conducting large-scale layoffs.

This distinction is very important. A slowdown in hiring may indicate cooling economic demand; simultaneous deterioration in hiring and layoffs is more closely aligned with signals of rapidly rising recession risks.

Therefore, the market hopes to see an orderly slowdown in employment rather than simply pursuing worse data. If new job additions are significantly above expectations, investors may reassess the necessity of further rate hikes by the Fed, and short-term U.S. Treasury yields and the dollar may gain support, while high-valuation tech stocks could face pressure.

If employment experiences negative growth again, the market reaction may not be positive either. Weak data may shift the trading focus from "Can the Fed pause rate hikes?" to "Is the U.S. economy accelerating downward?" thereby heating up recession trades.

According to the author's judgment, adding about 50,000 to 60,000 jobs while keeping the unemployment rate stable may be a relatively moderate combination: it can alleviate the Fed's concerns about an overheating labor market without rapidly amplifying expectations of economic recession.

The Fed's focus has shifted back to inflation

The reason why employment data cannot solely determine September's policy is that the main pressure the Fed currently faces still comes from inflation.

Fed Chairman Kevin Warsh stated in his speech at Jackson Hole that policymakers need to assess whether core inflation is rising, falling, or stagnating, while also paying attention to the speed of its changes. He pointed out that although several inflation indicators have significantly retreated from their 2022 peaks, the improvement over the past two years has been limited.

This statement did not directly commit to a rate hike in September but released a clearer signal: as long as there is no sustained evidence of a decline in core inflation, the Fed will not easily abandon tightening options due to a single month of weak employment.

The July meeting already showed this policy inclination. At that time, the Fed kept interest rates unchanged, but Beth Hammack, Neel Kashkari, and Lorie Logan cast dissenting votes, advocating for a 25 basis point rate hike. The support for a rate hike from these three members indicates that a clearer hawkish force has formed within the Federal Open Market Committee.

The meeting minutes further revealed that many participants believed that if inflation could not continue to decline, tightening policy might be needed in the future; some officials also judged that current financial conditions might not be sufficient to bring inflation back to 2%.

In other words, even if August employment cools moderately, as long as wage growth and inflation pressures remain high, hawkish officials still have reasons to support rate hikes.

Nonfarm data determines urgency, inflation data determines policy direction

With rising energy prices, increasing supply chain pressures, and hawkish signals from Fed officials, the rate market's pricing for a rate hike in September has recently warmed significantly.

This probability has strong intraday volatility. The original text states that the market's pricing for a 25 basis point rate hike in September once rose to 68% to 70%; after the weaker-than-expected ADP data was released, some real-time metrics fell back to about 61% to 64%. Therefore, a more accurate statement is: the market currently leans towards a rate hike but has not formed a stable consensus.

The August nonfarm payrolls will first test this expectation.

If new job additions are significantly above expectations, while average hourly earnings maintain rapid growth, the market may further increase the probability of a rate hike in September. Short-term U.S. Treasury yields and the dollar may receive support, while growth stocks sensitive to interest rates may face valuation pressure.

If employment approaches zero growth or turns negative again, and wage growth also slows down, the necessity for the Fed to raise rates immediately in September will decrease. The market may then re-bet on a policy hold, waiting for more data to confirm.

However, weak employment alone is still insufficient to change the policy path. The Fed simultaneously bears the dual responsibility of full employment and price stability, and when employment and inflation send conflicting signals, the policy choice depends on which risk is more urgent.

Therefore, the nonfarm report cannot only look at the number of new jobs added. The unemployment rate, labor participation rate, average hourly earnings, weekly hours worked, and prior value revisions are equally important. Weak new job additions but high wage growth may still be interpreted as limited labor supply rather than a clear decline in demand; only when employment and wages cool simultaneously can the rationale for rate hikes be more effectively weakened.

Next, we need to see if wages and CPI can cool simultaneously

After the August nonfarm payrolls, the market's attention will quickly turn to the August Consumer Price Index (CPI) to be released on September 11, followed by the Fed's meeting on September 15-16.

The key to verifying the logic of this article is not whether individual data points fall below expectations, but whether employment and inflation can form a consistent direction:

If employment grows moderately, wages slow down, and CPI cools, the urgency for the Fed to raise rates in September will significantly decrease;

If employment is stronger than expected, and wages and CPI remain high, the logic for rate hikes will be reinforced;

If employment deteriorates significantly but inflation remains high, the Fed will face the most challenging policy combination, and market volatility may rise accordingly.

Therefore, the August nonfarm payrolls are more likely to change the market's pricing of rate hike probabilities rather than solely determining the final outcome. What truly influences the September policy choice will be the evidence chain formed by employment, wages, and inflation data together.

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