Non-Farm Payrolls preview

Non-Farm Payrolls preview: markets on edge as we wait for key data

The December payrolls report is expected to show a sharp reduction in jobs growth at the end of 2024. Analysts are expecting a 165k increase in payrolls, this compares to a 227k increase for November. Private sector payrolls are also expected to moderate and grow by 140k, vs 194k in November. The unemployment rate is expected to remain steady at 4.2%, the highest level since August, and average hourly earnings are expected to stay at a 4% annual rate.

Lead indicators fail to give a clear signal ahead of payrolls

Ahead of the NFP report, the lead indicators for the labour market have been mixed. The ISM manufacturing employment component fell deeper into contraction territory in December to 45.3 from 48.1 in November, the employment component of the services sector ISM remained relatively steady at 51.4. However, Jolts job openings rose to the highest level since May and initial jobless claims also fell sharply, the 4-week moving average for December is 211k, down from 225k in November, the lowest level since April.

Average hourly earnings ticking higher could be headache for the Fed

Although jobs growth is expected to moderate, there are still pockets of strength in the labour market that could be inflationary. This is why the average earnings data is also a vital piece of information for this report. Monthly average hourly earnings data has been trending higher in recent months, compared with earlier in 2024. Although annual wage growth has been stable, the monthly figure could suggest that there is upward pressure brewing for wage inflation down the line.  

A moderation in jobs growth, yet elevated monthly inflation growth could make this report hard to decipher. On the one hand a softening labour market supports further easing from the Federal Reserve, on the other hand, stronger wage growth supports a high bar for future cuts.

Payrolls report may cement view that the Fed could pause for some time

The minutes from the December FOMC meeting suggests that Federal Reserve are less convinced that rates need to be cut in the near term. There are only two rate cuts priced in by the Fed for this year, and there is currently less than a 50% chance of a rate cut by June, according to the CME Fedwatch tool. The market is unconvinced about future rate cuts, but could this month’s payrolls report change that view?

If we get a large upward surprise, then we could see a further reduction in market expectations of future rate cuts from the Fed. In November there was a large upward surprise for payrolls, however, in recent months there has been some distortion to the figures due to adverse weather in October. A more convincing argument for an upward surprise to payrolls is the strength of the US economy. The Atlanta Fed’s GDPNow tool is predicting a 2.9% annual rate for GDP for Q4.

The market impact

Financial markets can experience large reactions to the US labour market report. The average move in the S&P 500 in the hours after a jobs report is flat over the past year, however, the highest move to the upside has been 1.1%, back in February, when payrolls grew by 236k. The largest decline has been a drop of 1.5% in September, after payrolls rose by 255k, which caused markets to worry about a slower pace of Fed rate cuts. The market is now expecting a slow pace of rate cuts, thus an upside surprise to NFPs on Friday may not trigger such a large negative reaction in US stocks. Interestingly, US small and mid-cap stocks have had smaller reactions to the NFP report compared to the S&P 500 in the past 12 months. In 8 out of the last 11 reports the Russell 2000 has declined in the hours after a payrolls release. Since the labour market was generally resilient in 2024, this suggests that mid-cap stocks are more sensitive to changes in expectations for Fed rate cuts compared to the blue chip S&P 500 index.

Will the dollar continue to rally after the payrolls report?

The dollar is also worth watching. On average over the last 12 months, the dollar index has risen by 0.2% in the hours after a payrolls report is released. The largest increase was a 0.9% increase in February, the largest decrease was a 0.79% drop in August. On balance, over the past year the dollar has tended to rise after a payrolls report. There has been a flight to safety to the dollar this week, and momentum for the greenback is to the upside. This means that the path of least resistance is for a stronger greenback, and it may take a large downside surprise in payrolls to knock sentiment towards the dollar.

Could a strong payrolls report sink the pound even more?

The financial backdrop to this report is also worth noting. The bond market sell off on Tuesday and Wednesday knocked risk sentiment, it hurt stock markets and it had a deep impact on the forex market. A strong report could add to the selling pressure on global bonds, and markets may be more sensitive than usual to any upside pressure in US Treasury yields. UK bonds have been moving closely with US Treasuries in recent months, so a strong payrolls report could add to the selling pressure on UK bonds and increase fears of a fiscal crisis in the UK. It could also weigh on the pound, which has been one of the weakest performers in the FX market since the start of this year.