Is the market too optimistic? Non-farm payrolls will be a key factor in adjusting expectations!

As U.S. inflation data steadily approaches the Federal Reserve's 2% target, policymakers' main focus has gradually shifted from suppressing inflation to supporting the labor market. This shift is justified, as the U.S. inflation rate has dropped to its lowest point in three years, while the unemployment rate reached a near three-year high in July this year, at 4.3%.

At the September Federal Reserve meeting, this stance was reinforced, with Fed policymakers noting that the risks to their dual mandate are "broadly balanced." However, despite implementing a significant 50 basis point rate cut, decision-makers continue to emphasize that the future rate path will depend on data.

Market Expectations and Fed Guidance Need to be Adjusted

Policymakers are expected to cut rates by 25 basis points each in November and December, but the market has doubts about this. Fed Chair Powell reiterated this position in his early Monday morning speech. However, market expectations tend to believe that there will be another 75 basis points cut before the end of the year, possibly 50 basis points in December. Ultimately, both sides will have to adjust their expectations, and as rate decisions will be made at "sequential meetings," analysts expect the market sentiment to be highly sensitive to the upcoming non-farm payroll report, as this will impact the Fed's rate path.

What to Watch for in Tonight's Non-Farm Payrolls?

Economists expect the U.S. economy to add 140,000 jobs in September, with the unemployment rate expected to remain at 4.2%. Data over the past few months has generally been below expectations, with job additions in the past two months falling short of expectations, and the unemployment rate has been higher than expected in five out of the last six months since April 2024.

While labor market growth is expected to slow down, as long as the U.S. labor market does not experience a significant downturn that would force the Fed to cut rates by 50 basis points in November, market sentiment may ease somewhat. Market analysis suggests that job growth between 120,000 and 180,000 can still be considered a normalization level before the pandemic, rather than a sign of economic deterioration.

As for the U.S. unemployment rate, if it remains at the current 4.2% or slightly rises to 4.3%, it is still within an acceptable range, as the Fed's latest economic projections show that the unemployment rate will reach 4.4% by the end of the year. Fed Chair Powell also mentioned that the current 4.2% unemployment rate is "healthy." The key risk for the market is if the unemployment rate significantly exceeds 4.4%, which would indicate that policymakers may have underestimated the risks to economic growth, forcing the Fed to accelerate rate cuts.

How are other labor market indicators performing?

This week's U.S. labor market data has been mixed. The Institute for Supply Management (ISM) manufacturing PMI data for September showed a worsening contraction in manufacturing employment, but the services PMI performed better than expected, indicating increased demand in the industry, with the index surpassing the 50 threshold for the third consecutive month. However, the employment index saw a slight decline, indicating some weakness in the job market in that sector However, this weakness contrasts sharply with the better-than-expected "small non-farm" ADP employment data and job vacancy data. In addition, the U.S. economic surprise index returned to positive territory for the first time since May 2024 this week. Overall, this supports the view of the ongoing weakness in the U.S. labor market, but is not enough to trigger alarm about an economic downturn.

How will the U.S. dollar perform next?

If the non-farm data shows that the U.S. labor market still has resilience, it will prompt the market to reassess expectations of interest rate cuts, with the current market view being more dovish than the Federal Reserve.

Analysts at the UK asset management company IG Group believe that the U.S. dollar has stabilized recently, and the current geopolitical tensions and uncertainty surrounding the U.S. election may provide some support for the U.S. dollar in the short term, but they remain cautious about a sustained rebound in the U.S. dollar. According to data from the Commodity Futures Trading Commission (CFTC), the U.S. dollar's net short position is still at its highest level in a year compared to other G10 currencies. Seasonal factors show that the U.S. dollar typically sees a slight increase from mid-October to November, but usually experiences a decline in December, which may drag down the U.S. dollar's overall performance for the year.