Made by nonfarm payrolls, ruined by nonfarm payrolls?

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The sharp decline in non-farm payrolls since July has continued to affect both the Federal Reserve and the market. Although other core employment indicators such as the unemployment rate and wages have not significantly worsened, there is consensus that the continual weakening of new non-farm jobs is the main reason that has forced the Federal Reserve to reassess employment risks and consider a “risk-control rate cut” in September.

However, we believe the Fed’s pace of rate cuts may be more complicated than the market’s expectation of a linear path. In previous reports, we have continuously highlighted that the potential inflation risk in the fourth quarter will become a “roadblock” to ongoing easing policies. Currently, the discussion about inflation is already quite thorough.

In this report, we focus on another key variable—employment—whether there is a possibility of upward revision, thereby suppressing the already priced-in expectations of rate cuts.

The “noise” in this year’s non-farm payroll data has become increasingly prominent: A significant drop in survey response rates, the Fed’s layoffs dragging down data collection quality, and other factors have all led to serious doubts about its accuracy. However, as the most central official employment indicator, both the market and the Fed still have to rely on its changes for pricing and decision-making.

On the other hand, the seasonal adjustment mechanism and model characteristics of non-farm data also amplify the short-term fluctuations. Because the Department of Labor incorporates new data each month into its seasonal adjustment model, generating new factors and retrospectively revising non-farm data for the last three months. July and August are often periods of high seasonal fluctuations in the job market, and after being included in the model, dynamic adjustment of the seasonal factors may increase short-term volatility in recent months’ data, leading to consecutive substantial downward revisions of non-farm payroll numbers.

However, historical experience shows that the preliminary August non-farm payroll figure announced in September is often seasonally revised upward in October. Referring to data from the past 20 years (2005-2024), the probability of the August non-farm figure being revised upward in the two revisions in October exceeds 80%, the highest for any month, while the probability that the final value announced in November is revised upward is also about 70%.

The overall magnitude of upward revisions is also not negligible, ranking among the top for the year from both the median and average perspectives. Given that July non-farm data has already shown signs of being revised upward, and combining this with White House economic advisor Hassett’s suggestion that the employment report could be revised upward by nearly 70,000 jobs, the potential upward revision of August non-farm data could have a significant impact on rate cut expectations.

We believe the reasons for the seasonal upward revisions in August non-farm data may include:

On the one hand, after the significant downward revision to the annual benchmark in September, the overall trend in non-farm payrolls in the CES model has shifted noticeably lower (the trend can be understood as a reference point for seasonal adjusted data; after shifting lower, previously “weak” data appears “strong” by comparison), so there is little room for further downward revision in the two subsequent revisions to August non-farm data announced in October;

On the other hand, as the unadjusted August non-farm figure typically rises notably for seasonal reasons, while not all survey responses are included in the preliminary data (especially now that the response rate has dropped considerably), subsequently collected surveys may reflect a more optimistic employment trend.

Compared with other labor market indicators, August non-farm also has a probability of being underestimated. The correlation between ADP employment, PMI employment index, SME hiring plans, etc. and the final non-farm value is generally higher than with the preliminary figure. Currently the drop in these indicators for August is controllable, without the sharp slowdown seen in the preliminary non-farm figure. This also suggests there is a certain probability of upward revision to August non-farm data.

Therefore, August non-farm payrolls may cause disturbances to rate cut expectations; a similar situation played out last year around the first Fed rate cut: Non-farm data for June–July was consecutively revised downward with the unemployment rate rising, triggering recession fears in the market and pushing the Fed to cut rates in September, with the market at one point pricing in another 50bp cut in November. However, in October the Department of Labor sharply revised up the July–August data, cooling the recession narrative and the aggressive 50bp cut expectation.

In terms of asset reaction, U.S. Treasury yields, especially at the short end (2-year), soared by about 20bps on the day; the US dollar rose, while prices of precious metals such as gold, silver, and copper fell sharply in the short term; US equities saw minor short-term pullbacks, but eventually continued to climb as recession narratives faded and moderate rate cuts supported prices. Of course, unlike last time, this round of asset pricing is mostly based on bets on rate cuts without recession narratives, which also means upward revisions to non-farm payrolls may have a greater negative impact on risk assets.

In summary, we need to continue observing rate cut expectations. Although we do not rule out the possibility of consecutive Fed rate cuts from Q4 through early next year (if there are clear upward signals in unemployment, etc.), current market bets on rate cuts appear a bit too aggressive and ignore potential volatility risks. Even though there are still internal disagreements among Fed officials, market pricing is showing rare “consistently optimistic” sentiment.

This also means that if any contrary signals (such as rapidly rising inflation or upward revisions to non-farm data) correct expectations, market volatility will be amplified again: US Treasury yields will rebound, US equity sectors relatively sensitive to rate cuts (growth stocks and cyclical stocks) will be affected, and metals with high financial attributes will see a slowdown in their rise (gold, silver, copper). Recent remarks by Powell are quite meaningful—emphasizing “rates remain moderately restrictive” and “stock valuations are high”—perhaps intentionally cooling overheated optimism.

Authors: Wu Shuo, Lin Yan, Source: ChuanYue Global Macro, Original Title: “Success or Failure Hinges on Non-Farm Payrolls?”

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