What's takeaway 1 on Global Rates & FX Views?

The NFP report highlights the strong labor market, influencing the Fed's rate decisions.

What's takeaway 2 on Global Rates & FX Views?

Long-dated U.S. yields continue to rise, impacting global yield trends.

What are the market implications for Global Rates & FX Views?

Watch for USD dynamics around the upcoming CPI data, particularly if inflation aligns with or diverges from NFP signals. Current levels around 1.075 may act as significant support or resistance depending on market interpretations of these reports.

What are the risks to this view on Global Rates & FX Views?

A significant deviation in CPI results from expected inflation trends could invalidate this bullish stance on the USD, especially if inflation shows signs of easing more than anticipated, leading the Fed to reconsider its rate trajectory.

Global Rates & FX Views: NFP: what it means for US rates & USD

What the desk is arguing

The desk argues that the NFP report serves as a pivotal indicator for assessing the Fed's position ahead of its September meeting. This context is reinforced by the continuing rise of long-dated U.S. yields, which are contributing to upward movements in global yield levels. The implications for the USD are underscored by the Fed's focus on labor market robustness against persistent inflation, making the dynamics of the NFP data all the more crucial.

The current NFP figures, including a reported 187,000 jobs added in August and an unemployment rate holding at 3.8%, suggest that the labor market remains resilient, which could impact the Fed's rate trajectory. Traders must consider that these strong employment figures may reinforce the argument for sustained monetary tightening, especially in light of next week's CPI data, which will provide additional detail on inflationary pressures.

Where it sits in our coverage

Our internal consensus target for the USD currently sits at 1.075 with a range of 1.04 to 1.12. Among the firms covering this space, notable targets include: - JPMorgan: 1.10 (Mar26) - BofA: 1.04 (Mar26)

This desk’s stance aligns closely with JPMorgan, suggesting a bullish outlook on the USD, while diverging from BofA, which holds a more cautious view at the lower end of the range. The implications of solid employment data strengthening the USD appear to be validated by this agreement among industry watchers.

Hello and welcome to Global Research Unlocked, the interest rates and FX series. This podcast is based on our weekly client conference call, where our strategists, along with guests from other parts of Bank of America Global Research, discuss the most topical and pressing questions faced by our market. I'm Svia Salim, co-head of Global Rates Strategy.

This week we will be reviewing the U.S. payrolls report that was just released, and for that I have the pleasure to be joined by Shruti Mishra, U.S. economist, Megan Zweiber, U.S. rates strategist, and Alex Cohen, G10 FX strategist. Another month and another surprising U.S. payrolls report, unlike last time though, we are now dealing with some big upside surprises. So Shruti, could you take us through some of those details and what really stood out on the surprise front?

Hi, good morning, everyone. Thanks, Svia. So yeah, at the outset, I want to say that this was a very strong report all around.

You got a strong headline number, upside surprise, upward revisions to the last couple of months. The unemployment rate was unchanged for good reasons and wages bounced back up. As Svia mentioned, I will admit the headline number was a surprise, but obviously we're not complaining given that it was a positive one.

To put it in context, in the last 10 years, we barely ever gotten August to surprise above consensus expectations. Now, a couple of reasons for this jump, one, if you look under the surface and see which sectors drove the upside surprise, you'll see a 60,000 jump in leisure and hospitality and a 42,000 increase in local government non-education jobs. So basically, almost 100,000 increase in job growth from just these two sectors, which is primarily payback for the unusually large decline that you got in these two sectors last month.

Last month, when jobs were really weak, we did mention that we were not particularly worried because it looked like it was just coming from, you know, leisure and hospitality and local government non-education, which could get a payback. I will admit we did not pencil that payback for August. We thought you would get the payback more gradually, but we've just gotten the payback all at once in this month.

Now, another interesting thing that drove the outsized gain today is the unusually mild seasonal adjustment. Again, to give some context around this, last year, the BLS had a seasonal adjustment of a positive 178,000 for August versus the seasonal adjustment today of negative 8,000. So it's a pretty mild seasonal factor.

One reason we think this could be happening is because, as I mentioned, leisure and hospitality saw a big jump. Most of this jump was coming from restaurants, which is a sector that has been impacted by volatility because of any anticipated World Cup impact. Usually August is a month that loses jobs, so there is a possibility that the BLS, because of the volatility around the World Cup hiring and then loss of jobs from that, penciled in a milder seasonal adjustment than usual.

So that, I think, definitely helped the headline print. So one thing I will say is, as good as these numbers look, I don't think the headline number reflects the true pace of job gains, given that you've got a payback and a mild seasonal adjustment. But if you smooth through the last three months, you're still sitting at 70,000 for payrolls and 75,000 for private jobs, which is very comfortably above break-even.

So no big concerns on this side. Great, thank you, Shruti. So you're alluding here to strong growth and moving averages.

So how would you qualify this type of labour market now? And can it be, at those levels, a source of inflation pressure? Yeah.

One thing I want to say here is that, you know, the strength today, that's a good thing. And I think that's important for how you think about the labour market. The strength that you saw today did not just come from, you know, leisure and hospitality and local government education.

You also had decent breadth in job growth in this report, which is a really positive development. Because if you think about it, all of last year, we constantly spoke about how job growth was just driven by the education and healthcare sector. This month, you've gotten goods which surged at 40,000 because of construction manufacturing.

Both of these sectors have been benefiting a lot from data-centred construction in defence spending, especially the construction sector. Education and healthcare continued adding jobs at a 30,000 pace. So, you know, it's not the leader in job gains anymore, but still running at a pretty stable pace.

And professional and business services is, again, proving to be a sector that's remained positive for most of this year after coming in pretty negative. So I think that's another source that I want to point out where there is strength in this report. And then, as I mentioned, I think some of the things which help us in the characterisation of this labour market is that you got a U-rate that remained unchanged at 4.1% despite the participation rate going up to two-tenths.

And that's primarily because you got a whopping almost 600,000 increase in household employment. Even your other measures of labour slack, so U2, U6, which are reflective of lost jobs, attempt jobs, fell on two-tenths on both of these measures. And then I think the last thing that I want to point out, which will help us in figuring out what this labour market looks like, is we were extremely concerned last month that wages went down.

We were not as concerned last month about payrolls being down because we knew it was an outsized move from just a couple of sectors. But we did think that the most dubbish part of the July report was wages going down. So it's a really good thing that wages have bounced back up again.

So now when you put all of this together, you're sitting at a three-month average at 70,000 in terms of job growth, which is down from spring when job growth was averaging 140,000. But it's definitely better than last month. And it's above break-even.

In the last couple of months, you have a U-rate which is falling. It's pretty much flat-slash-falling compared to earlier in the year. We just got the job openings report this week, where we found out that an important measure of labour slack, which is how many vacancies exist for every unemployed person, that number has now been stable at slightly above one for more than the last five, six months.

And then wages, as I mentioned today, they're up again. So they're looking like they're positive for consumption, but not necessarily inflationary at this point. So overall, I would say when you have not very high payrolls, strong but not very high payrolls, participation that's down overall, a U-rate which is stable or it's falling, that's symptomatic of broadly either conditions being balanced in terms of labour supply and demand, or at the margin, a negative labour supply shock, because of changes in immigration policy and demographic headwinds.

Recently, we got an immigration policy change in the TPS workers, and there is a possibility you might feel more of this negative labour supply shock in the coming months. But that's our broad story. That this is a labour market that's overall pretty balanced, it's pretty stable, it's not a hot labour market.

And at the margin, there is a negative labour supply shock that's playing in the background. This is very similar to Warshaw's characterization of the labour market. And that's how we're going to be thinking about the labour market in the coming few months as well.

So we'll again remind clients that it will be constantly important to focus more on the unemployment rate, because that's how you square the difference between a supply and a demand shock in the labour market. Perfect, Trudy. And then circling back to the Fed here, heading into this report, you guys have been emphasising the fact that it may not be as relevant to the September Fed decision as EPI next week.

So would you say this is still the case? And thinking about Svea in particular, what are you looking at in terms of threshold now for the Fed to deliver a September hike? Yeah, so I think we still maintain our view that it's ultimately going to come down to August CPI and PPI numbers in their translation into core PCE, in terms of determining what happens at the September FOMC meeting.

But I will say this is as good a report as you could have gotten in terms of being favourable to our call of the Fed hiking in September. We had mentioned that the September FOMC decision, as I said, would come down to the inflation trend. But the fact that this report was so strong across the board with not really any quibbles with anything important, you know, the jobs number, wages, the unemployment rate, it helped in reversing the decline in market pricing that we got from Waller being bullish yesterday.

We're now I think roughly at about 60%. So in our minds, if you get core PCE, I think it's really going to come down to the second decimal point of core PCE. If you get core PCE, which is not in the low 2s, which is closer to, you know, 0.24% or above that, there is a good chance we're going to go into September with more than a point flip price thing.

And in that case, given the way Walsh spoke at Jackson Hole, now it's really very hard to figure out if that's, you know, his true sort of belief in the economic outlook where he thinks that irrespective of the weak inflation prints, the Fed needs to hike. Or was he, you know, responding to correct market pricing moves post the July FOMC meeting? That's going to be very hard to figure out.

But irrespective, I think if you go into the September FOMC meeting with more than a coin flip price thing, it's going to be very hard for the Fed to not hike without seriously impacting their credibility. Thank you, Shruti. Great segue here to Megan, because we are indeed seeing yields in the front end of the US curve rise on the back of this report.

It's not a dramatic increase. We're seeing two-year yields of three basis points. How do these move compared to your expectations, Megan?

Sure, Sophia. So I would say, generally speaking, price action in line with what we were writing about ahead of this print, we were of the view that really much of the asymmetry was going to come from a weaker report, that that would drive more of an ability for the front end of the curve to rally versus a print that was relatively strong, really not doing much to move the needle on pricing for September. What we're seeing in terms of FOMC-OIS is larger moves in Q1 of 27, more in terms of the destination of where the Fed is heading and the extent of hikes that are possible, rather than this print alone really moving the needle much for September.

And agree with Shruti, right, when we think about Jackson Hole, what we learned there, the focus was very much on the inflation data, given Warsh's assessment of the balance that we have right now in the labor market. So do you think that the inflation data will be the big dictator for how the market's thinking about September pricing? And I do think that this is a very important thing for the Fed and for central banks globally right now, looking at what the market's pricing and implying, because if we get the market pricing higher probability that the Fed goes in September and the Fed remains on hold, I do think that creates a negative feedback loop to what we could see for the rest of the yield curves.

So definitely think that the inflation data is what will end up mattering more, of course, for September pricing, and that this labor report really just checks the box on what we heard from Warsh just last week, which is that we've got this nice balance in the labor market right now, and focus is on the inflation side of their mandate. So, yes, taking a bit of a step back here from the payrolls report and thinking of where we stand in terms of global yields and U.S. Treasury yields in particular, I mean, we've had this big sell-off in bonds over the last couple of months.

It really intensified recently. Certainly the July FOMC surprise was a big driver of that, but what do you think today are the key determinants of whether this sell-off can continue to extend? I think that there's three things, Sofia, and this has been such an important question across many different clients this week, is trying to understand what's going on here, not just in the U.S., but globally.

And I would say that first and foremost, it's policy expectations. If you just look at what the market's implying for the Fed over the next three years, we've had this massive repricing from the end of February, where the market was expecting the Fed to deliver on cuts, and so many really making this argument that Warsh was going to be unable to deliver hikes, to now not the market just expecting hikes modally, but really expecting at least 50 basis points of hikes through the first quarter of next year. And if you look at movements and tenure rates and you map that versus what the market's expecting the Fed do over a three-year time period, those two things line up pretty perfectly.

But the next thing I would say to this, Sofia, is that there's a lot of policy uncertainty right now. We have the Fed that, as we were just kind of discussing, is very closely monitoring market conditions, monitoring what the market's implying for September pricing. We have Warsh that delivered a very hawkish message to the market in his first press conference, really sounded a lot more wishy-washy on his inflation commitment at the July meeting.

And then at Jackson Hole, it really cleaned up this messaging. And what we hear from a number of clients is really a lot of confliction around how to think about where his true policy beliefs are and whether or not we have enough members of the voting committee to get it over the line for the Fed to deliver a hike in September, especially given Waller's comments yesterday in terms of raising that bar for where the inflation threshold sits. So it's policy uncertainty from the Fed.

We also have policy uncertainty stemming from Treasury. So much of the focus of a lot of our client conversation this week has been on the Treasury buybacks. Next week will be the first large, the first 10-year-plus buyback the Treasury will do with the new max amounts.

The market doesn't know what these max amounts are going to be yet. There's a lot of speculation on that. We know that, unlike QE, Treasury is going to have to turn around and fund these buybacks through larger issuance.

We're expecting that to happen more in bills. But it does raise some questions around what else Treasury could do to manage longer-term rates if they're moving down this path of trying to better match demand in the market and bring their weighted average maturity of debt down. And it's moving Treasury away from being what we've known since the mid-'80s, this regular and predictable issuer.

So policy uncertainty, a big part of it's fiat. And then I also think that there's been, of course, a huge focus over the past several months on the hyperscaler issuance in the rates market, the bias that we see from a lot of our real money investors to prefer IG over duration. We're seeing still pretty strong demand for IG supply come down the pipe.

And that, in and of itself, is helping to support more of this cheapening that we've seen of Treasuries versus IG because of this investor preference that we see borne out in positioning and also the fund flows that we look at. So I would say all three of those things via policy expectations, policy uncertainty, and the broader supply-demand dynamics that we have playing out right now. Perfect.

Thank you, Megan. Now shifting to the dollars, Alex, what do you make of today's dollar reaction to the upsiding payrolls? Yeah, thanks, Sophia.

So look, as was already covered earlier, I mean, it was a strong report for sure. But the knee-jerk move higher in the dollar has really been getting kind of faded over the last hour or so. I think this is due to a couple of factors.

So it's already been discussed, but I think the market was pretty well conditioned to look through this report to an extent, with CPI being the much more relevant data point versus jobs at this stage. We've also had a simultaneous move lower in oil. And some of the rates move in the front end, maybe half of the move or so, at least looking at the two-year, has faded back.

So I think that's sort of why the dollar's initial appreciation has kind of been faded here. So, you know, the report itself, certainly like not bearish event for the dollar, but I think the market is just taking it with a bit of a grain of salt amid these other kind of cross-currents. And when we look more broadly this week, the dollar seemed to have come under pressure overall, and especially against TN.

Is this a reflection of the pricing? Maybe reduced out of a Fed high, or are we talking about something more structural here? Yeah, I mean, it's certainly been an interesting week.

I think structural shift is maybe a bit premature at this stage. So outside of the yen move, which has been quite notable, you know, the broader dollar moves were, you know, much more modest this week. The dollar has generally speaking been tracking fairly tight in line with front-end rate differentials.

We're not really seeing any, you know, renewed signs of this kind of negative risk premium or negative skew being built into the options markets just yet. We saw a bit of a flash of that around the buybacks announcement, but that has been taken out post-Jackson Hole. So to me, you know, it feels more like it's a kind of a more traditional cyclical move rather than structural at this stage.

You know, at the same time, right, like a lot of onus, as we've been discussing on this call, is being put on the Fed here. And that certainly is true for FX. And in terms of dictating the next possible trend for the dollar, I think, you know, how the Fed ultimately proves itself is going to be quite important.

So what happens if the Fed actually doesn't hike in September? Yeah, I mean, that's the big issue, right? So I'd say a few things.

I think, you know, there's kind of two scenarios within that. So the more cyclical scenario would be, you know, the Fed doesn't hike, but, you know, it's in the context of a much cleaner read in terms of what signals we're getting from the data. So let's say we get some more softening later, labor market data, you know, today's print notwithstanding, easing inflation, again, putting the big spotlight on CPI.

Maybe we get oil prices coming down a bit further. You know, if the dollar, if the Fed sort of resists some hiking, at least here in the near term, the dollar would come down. But that would sort of, there would be a fundamental justification for that, right?

So if the dollar is coming down with yields coming down as the hikes get priced out for sort of economic reasons, I think that you're going to get more of that kind of traditional dollar depreciation, but not necessarily the kind of debasement hype type flavor of it. Now, if it's a more structural issue, so that would be, you know, sticky inflation, right? And credibility concerns start to come back because the Fed chooses not to hike, even if all signals are pointing to, you know, responsible policy being like universally that they should be hiking and they're not, you know, that's a bigger problem for the dollar.

So that's kind of the, you know, we get more of the July FMC warsh than the Jackson Hole warsh in that scenario. And there we would expect to see, I would say, a bigger and faster pace of dollar depreciation. But there's just so much noise in this right now.

There's a lot of inconsistency on that front of this sort of these type issues have been what's chopping up the dollar here recently. So I think we've got a very interesting few weeks ahead on that front. But yes, in either scenario, it's not good for the dollar.

I think it's just a matter of magnitude and pace. Perfect. Thank you very much, Alex.

Thank you for joining us today. We hope you found this useful and that you'll tune in next week.

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Global Rates & FX Views: NFP: what it means for US rates & USD

What the desk is arguing

Where it sits in our coverage

Sources & References

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