US employment rate unexpectedly falls to 3.5%. Data supports higher US rates and USD; US equities tumble

The key focus for the market on Friday was the US employment report. The unemployment rate fell 2 ticks to revisit its recent low of 3.5%, triggering higher US rates, a higher USD and weaker equities, consistent with the good news is bad news mantra, as data like that can only encourage the Fed to keep applying the brakes. The NZD fell just below 0.56 and closed the week just over level, while the AUD traded at a fresh 2½-year low of 0.6355.

US employment growth continued to show signs of slowing, with nonfarm payrolls up by 263k in September, in line with the consensus and the weakest reading since April 2021.  Average hourly earnings were also in line, at 0.3% m/m and 5.0% y/y, showing signs of slowing as well but still incompatible with an inflation target of 2%. However, a lower participation rate drove the unemployment rate down 2 ticks to 3.5%, matching the recent historical low. The bottom line is that the labour market remains too tight for comfort, supporting the Fed’s case to continue along it tightening path that will take policy well into restrictive territory.

With no more payrolls releases before the November FOMC meeting, the market moved to increase the chance of a 75bps hike, now almost fully priced and, barring a big negative surprise for this week’s CPI release or a financial market meltdown over the next few weeks, looks like a done deal. US Treasury yields rose about 5-7bps across the curve on the day, extending the sell-off seen over the previous sessions, with the 10-year rate closing the week at 3.88%.

NY Fed President Williams, speaking after the release, said that the US has a very strong job market and that the Fed needs to raise rates to “somewhere around 4.5% over time”, with the timing and how high rates need to go depending on the data.

The equity market reaction was more significant, with the S&P500 tumbling 2.8%, the market building in the increased chance of much further policy tightening ahead killing the economy. Still, the fall should be seen in the context of the strong rally earlier in the week, and the index still rose 1.4% for the week, breaking a three-week run of chunky falls.

The employment report gave further support for the USD, with dollar indices up 0.4-0.5% on the day, close to the fall seen in EUR to around 0.9740, with GBP showing a slightly larger fall to back below 1.11. CAD was the only key major to hold its ground against the USD, supported by the Canadian employment report released at the same time as the US.  Canada’s unemployment rate also fell 2 ticks to 5.2%, partially reversing the rise in August.  USD/JPY tracked above 145, back to the levels that triggered the MoF’s USD20b currency intervention a couple of weeks ago.

The NZD was one of the worst performers, taking a brief peek just below 0.56 before closing the week just above that level – capping off a volatile week that saw it whip around about a 0.56-0.58 range. The AUD traded at a fresh 2½-year low of 0.6355, closing the week not much higher than that. NZD/AUD fell slightly and closed the week just above 0.88, back to the level prevailing just before the RBNZ’s 50bps hike on Thursday, and not much higher than before the RBA’s smaller than expected 25bps hike last Tuesday.

China’s foreign reserves fell USD26b to USD3029b in September, driven by valuation changes and with no evidence that the PBoC had been selling FX reserves to prop up the yuan.  The PBoC has been using other means to support the yuan, including changes to FX reserve ratio requirements and encouraging state banks to buy yuan with surplus US dollars. China’s Caixin services index fell nearly 6 points in September to 49.3, as the zero-COVID policy and various lockdowns took their toll on the services sector. China’s COVID19 cases are on the rise again, to a five-week high, with evidence of community transmission in Beijing and Shanghai, ahead of the 5-yearly Leadership Congress that begins next weekend to re-elect President Xi.

The domestic rates market saw significant upside pressure, driven largely by global forces, with swap rates up 8-11bps and NZGB rates up 11-12bps. Daily moves of this size in both directions have become common, consistent with the increased volatility seen in other markets.

On Saturday, an explosion – blamed on Ukraine – damaged the Kerch Straight Bridge linking the occupied Crimean Peninsula with Russia. This will impede Russia’s ability to wage war in southern Ukraine and is another blow to Putin. It remains to be seen how Russia will retaliate and, while Russian attacks on Ukrainian residential buildings and civil infrastructure have continued over the weekend, it’s probably fair to say that the chance of deployment of a mini-nuke is higher than it was last week.

In the week ahead, the US CPI on Thursday night is the key focus, with the market seeing lower gasoline prices weighing on the headline rate (0.2% m/m expected), and core inflation remaining uncomfortably strong, at 0.4% m/m and 6.5% y/y.  The latter would match the high in annual core inflation seen in March, not a good look. The US earnings season kicks off later in the week, but it’ll be off to a quiet start with the US public holiday and only a couple of Fed speakers on the calendar.