The Fed and March US non-farm payrolls report and the ECB’s end to the tightening cycle

Stephen Miller

“Give me a one-handed economist. All my economists say “on the one hand…, but then on the other…”   Harry Truman (US President 1945-53)

Where is the Fed coming into the March US non-farm payrolls report?

The March US monthly non-farm payrolls report to be released on Friday will of course be keenly watched. The report comes at a time when markets are again questioning whether the first Federal Reserve (Fed) policy rate cut is as proximate as once thought.

At the start of the year the bond market was anticipating something close to 175 basis points (bps) of policy rate cuts or seven different episodes of 25 bp cuts. To put that in perspective, that would have required a rate cut at every meeting following the Fed meeting concluding on 31 January. In other words, the Fed was expected to commence cutting the policy rate in March.

That view took hold despite the Fed’s median “dot plot”, issued after the meeting concluding on 13 December 2023, implying “only” 75 bps of policy rate cuts or three 25 bp reductions for 2024, taking that rate to 4.6 per cent by year-end.

At the most recent Fed meeting on 19-20 March this year, the Fed reaffirmed its expectation of “only” 75bps of policy rate cuts this year. Further, the pace of policy rate reduction in 2025 was tempered from December to reflect just three 25 basis point policy rate reductions from the previous four, leaving the policy rate at 3.9 per cent as opposed to the 3.6 per cent projected back in December.

Markets grudgingly became more aligned with the Fed view. Nevertheless, since the commencement of the policy tightening process in early 2022, markets have exhibited an ongoing predilection to “false start” on rate cuts. That is despite some recent disappointments on inflation.

Just last week the Fed’s favoured measure of inflation, the core private consumption expenditures (PCE) price index, showed ongoing “sticky” attributes. The 3-month annualised rate of change to February 2024 was 3.5 per cent, the highest since May 2023.

That seems hard to reconcile with any surprise early rate cut from the Fed.

Fed Chair Powell’s comments on Wednesday did little to excite expectations of an “early” Fed policy rate reduction. While noting that recent higher-than-expected inflation figures didn’t “materially change” the overall picture and adding that “most FOMC participants see it as likely to be appropriate to begin lowering the policy rate at some point this year,” he gave no indication that such a move was imminent.

Financial markets see roughly a 60 per cent chance of a rate cut in June and a total of around 70 bps worth of reductions this year. My suspicion is that markets will continue to be disappointed given the “stickiness” in inflation.

It is the case that rather than being “immaculate” and smooth, the process of disinflation tends to be more disjointed: a process of “two steps forward and one step back” with the “last mile” to the inflation target proving particularly challenging, particularly in an environment (such as in the US) where economic activity is resilient.

As I have remarked in the past, there are key structural elements at work that will make that “last mile” even more daunting. The globalisation of labour supply (after the fall of the Berlin Wall and the “export” of labour from large emerging market economies such as China and India) is abating; globalisation of goods markets is in retreat as governments everywhere introduce protectionist measures under the guise of “industrial policy” and “national champions”. Incredibly, one of the very few things that unites President Biden and candidate Trump is the embrace of tariff protection – long an anathema to mainstream economic thought. They also share a proclivity for greater domestic regulation of goods and labour markets, leading to upward price pressures. Finally declining baby-boomer workforce participation may lead to upward price pressure as labour supply shortages result in “sticky” wage inflation.

Ahead of the March payrolls report, Fed Chair Powell has characterised the current state of the labour market as close to “what we want to see.”

But as important as the payrolls data are, in the absence of a report a long way from expectations, it will be progress on inflation that will determine whether the Fed chooses to enact any policy rate cuts.

In this context, markets will likely be particularly exercised regarding the extent to which the March report reveals some tempering of wage pressure as well as focussing on conventional measures of employment growth and the unemployment rate. Decelerating wage growth would encourage a more positive narrative on inflation abatement and a more positive backdrop for financial markets and vice versa.

The consensus estimates for November non-farm payrolls are for an increase in employment of around 200k), an unchanged unemployment rate at 3.9 per cent, and for average hourly earnings to slow to 4.1 per cent annual growth from an upside surprise of 4.3 per cent in February.

The February Job Openings and Labour Turnover Survey (JOLTS) report released on Tuesday was consistent with some modest easing of labour market conditions but failed to alter an overarching picture of ongoing resilience.

The ADP March payrolls report released on Wednesday paints a similar picture with a 184k increase in private payrolls in March (versus an expected 150k gain). While a reasonable enough indicator in and of itself, its record in foreshadowing month-to-month movements in the Bureau of Labor Statistics payrolls measure is at best mixed.

An outcome close to expectations for the aforementioned components of the BLS non-farm payrolls report won’t move the dial for the Fed to where markets reside.

The real test comes next week with the release of the March US consumer price index (CPI) on Wednesday 10 April.

My sense is that inflation may prove “stickier” than anticipated and that accordingly the Fed is still some way from contemplating any policy rate cuts – maybe not until toward the end of 2024.

That means the extent of easing currently priced into markets – while maybe not implausible – implies a policy rate path through 2024 that is located at the low end of the risk continuum.

ECB: “overachieving” on inflation (or “underachieving” on activity) implies an end to the tightening cycle

In somewhat of a contrast to the US, Eurozone inflation continues to surprise on the downside.

In essence that reflects weak economic activity, partly driven by Europe’s vulnerability to the ongoing fallout from the Russia / Ukraine conflict and also deep structural weaknesses.

Eurozone March core CPI came in at 2.9 per cent which was a modest downside surprise from the expected 3 per cent, albeit that that expectation itself reflected previously released downside surprises in Eurozone national CPIs.

The inflation data supports expectations the European Central Bank (ECB) will cut policy rates in coming months.

Unlike the Fed which can contemplate a reduction in the policy rate from a position of strength, the ECB does so from a position of abject weakness.

ECB President Christine Lagarde has previously stated that “we will know a bit more by April and a lot more by June”. The ECB meets next week. At this stage a cut in the ECB policy rates looks unlikely with the rates applying on the deposit facility, main refinancing operations and marginal lending facility remaining at 4.00 per cent; 4.50 per cent; and 4.75 per cent respectively, but Lagarde is likely to frame the decision as a “dovish hold” and intimate a strong likelihood of a June reduction.

That said, with the Swiss National Bank (SNB) surprising with a March cut in their policy rate, and given dire activity growth, the prospect of an ECB rate cut in April – while a surprise – would not necessarily shock.

By Stephen Miller, investment strategist