Will the non-farm payrolls report lead to a 50 basis point interest rate cut?

After the release of the July non-farm payrolls data, the Federal Reserve's policy choice has shifted from "Will rates be cut in September?" to "Will it be a 25bp or 50bp cut?" The most important shift in the Fed's interest rate meeting on Thursday is the shift of policy focus from inflation to employment. The July non-farm payrolls data showed a general cooling down, which can be seen as a subtle coincidence.

The most eye-catching aspect among many data points is the rise in unemployment rate, touching the critical point of the Sam rule. Historically, this is often an important feature of an economic recession and has become a key factor for the market to bet on a 50bp rate cut in September. However, the biggest difference this time compared to history is that the triggering of the Sam rule precedes the recession and rate cuts. Considering the impact of unusual weather in July, the July non-farm payrolls have opened the door for a rate cut in September, but may not yet be sufficient reason for a 50bp cut. In addition, against the backdrop of this year's election, the "side effect" of a significant cooling down in non-farm payrolls may make the path for Harris to the White House even more difficult.

The signal and noise of the unemployment rate breaking the "Sam rule". In July, the unemployment rate rose to 4.3%, in line with market expectations and unchanged from the previous value of 4.1%. The "Sam rule" indicates that if the 3-month moving average of the unemployment rate is 0.5% higher than the lowest point in the past 12 months, it indicates that the U.S. has entered the early stage of an economic recession. Rounded off, this indicator has now risen to 0.53% in July.

So, will a recession definitely occur? Although this rule has successfully predicted every recession since 1948, this time there is indeed a probability of it being an "exception". The current labor market is different from historical early recession situations: first, the layoff rate is still low and has not started to rise. Second, the labor force participation rate has increased, accelerating the rise in the unemployment rate, rising by 0.1 percentage point to 62.7% in July.

Third, looking at the structure of the unemployed population: the unemployed can be divided into 4 categories based on the reasons for unemployment: New Entrants, Reentrants, Job Leavers, and Job Losers. The proportion of "New Entrants" among the total unemployed has increased, partly due to a significant increase in immigrants and the post-pandemic remote work order bringing more disabled individuals into the labor market. In historical recession periods, the proportion of "New Entrants" has always decreased. This reflects the contribution of immigrants and other "New Entrants" to the magnitude of the current rise in the unemployment rate

In addition, due to the impact of Hurricane "Beryl", the unemployment rate in July may be somewhat "artificially high". On July 8th, Hurricane "Beryl" made landfall in Texas, USA, and the number of initial jobless claims in Texas increased significantly after the hurricane. The subcategory of "temporarily unemployed population" in the total unemployed population in July surged to 1.06 million people, up from around 850,000 people before. Roughly estimating, the hurricane may have brought an increase of 150,000 to 200,000 people to the unemployed population, pushing the unemployment rate up by 0.1 percentage point. Excluding the impact of the hurricane, calculated at an unemployment rate of 4.2%, this indicator is close to the 0.5% threshold.

However, this does not deny the overall cooling of the job market. Non-farm payroll growth fell significantly below expectations, with previous figures revised downward again. In July, non-farm payrolls increased by 114,000 people, well below the market expectation of 175,000 people. The data for June was revised down from 206,000 to 179,000, and the data for May was revised down from 218,000 to 216,000. By industry, healthcare continued to be the main contributor to job growth, adding 64,000 jobs in July; the leisure and hospitality industry improved, adding 23,000 jobs in July, possibly due to the peak season for summer service consumption; manufacturing job growth remained sluggish, with the employment sub-index of the July ISM Manufacturing PMI falling to 43.4, the lowest since July 2020. Hourly wage growth cooled more than expected, dropping by 0.2 percentage points to 3.6% in July.

Regardless of a recession, the door to rate cuts in September is already halfway open. The most important shift in the Fed's July meeting was a pivot of policy focus from inflation to employment. It is no longer a question of whether there will be a rate cut in September, but rather a question of whether it will be 25 basis points or 50 basis points. After the July employment data was released, gold hit a historical high, and the 2-year US Treasury yield fell from 4.1% to 3.9% intraday. CME FedWatch Tool shows that the probability of a direct 50 basis point rate cut in September has exceeded 60%.

How does poor employment affect the election results? The likelihood of a change in ruling party is higher. Reviewing election years since 1980, the employment situation in swing states and the final election results reveal that in election years with a change in ruling party, the average unemployment rate in swing states from June to October is 0.8 percentage points higher than the previous year's low point; whereas in election years with the ruling party staying in power, the average unemployment rate in swing states from June to October is 0.02 percentage points lower than the previous year's low point. This implies that a marginal deterioration in the employment situation in swing states often corresponds to a change in ruling party Against the backdrop of the ongoing rise in unemployment rates, the possibility of the Democratic Party (the ruling party) winning this year's election is further reduced.

Author: Tao Chuan (S0600520050002), Wu Bin, Source: Chuan Yue Global Macro, Original Title: "Will Non-Farm Payrolls Trigger a 50bp Rate Cut?"