US Jobs Slowdown Eases Immediate Pressure, but Inflation and Fiscal Policy Keep Fed on Alert

What happened

Softer US jobs data in September indicate a potential slowdown in the labor market. According to Ira Jersey, Bloomberg Intelligence's Chief US Interest Rate Strategist, this moderation could offer the Federal Reserve (Fed) flexibility to keep interest rates unchanged at its October meeting. However, persistent inflation remains a central concern for policymakers.

Furthermore, strong economic growth and what is considered loose fiscal policy are contributing to rising global bond yields. This combination of factors maintains pressure on central banks, including the Fed, to continue fighting inflation, suggesting that any rate pause might be temporary, with the possibility of further hikes in December and early next year.

Why it matters

The interplay between jobs data, inflation, and fiscal policy is crucial for the Fed's monetary policy trajectory. A slowdown in the labor market is generally seen as a sign of economic cooling, which could ease inflationary pressures and justify a pause in rate hikes. However, if inflation remains elevated, even with a less heated labor market, the Fed may feel compelled to resume monetary tightening.

The persistence of elevated global bond yields, driven by robust economic growth and fiscal policy, reflects the expectation that interest rates will remain high for longer. This has significant implications for the cost of capital, government and corporate borrowing, and asset valuations worldwide.

Market impact

• Interest rates and bonds: The expectation of a Fed pause in October, but with the potential for further hikes in December and early next year, tends to keep Treasury yields elevated. The short end of the curve may react to weaker data, but the long end should remain pressured by inflation expectations and fiscal policy, leading to a potentially steeper or stable yield curve at high levels.
• Dollar and FX: A Fed that signals the possibility of more rate hikes in the future, even with weaker jobs data, tends to sustain the dollar's strength. The favorable US interest rate differential, combined with global uncertainty, may keep the dollar appreciated against other currencies, including the Brazilian real.
• Equities: Uncertainty about the trajectory of interest rates and the cost of capital tends to generate volatility in equity markets. Companies with high leverage or those dependent on financing may be more negatively impacted. Defensive sectors or those with strong cash generation may show greater resilience. A pause in October might provide short-term relief, but the prospect of further hikes could limit gains.
• Brazil: The global scenario of higher-for-longer interest rates and a strong dollar tends to pressure Brazilian assets. The real may depreciate against the dollar, and local interest rate futures may rise, reflecting the need to maintain an attractive interest rate differential. The Ibovespa may suffer from foreign capital outflow and the increased cost of capital for listed companies.

What to watch

Upcoming inflation data (Consumer Price Index - CPI, and Producer Price Index - PPI) will be crucial to confirm or invalidate the reading of persistent inflation. Additionally, subsequent employment reports and statements from Fed members will provide further clarity on the direction of monetary policy. The evolution of US fiscal policy will also be an important factor to monitor.

Scenarios

Base Case: The Fed holds rates steady in October but signals a hawkish stance, with the possibility of one or two additional hikes by early next year if inflation does not subside. Treasury yields remain elevated, and the dollar stays strong. Risk Scenario: Inflation surprises to the upside in the coming months, forcing the Fed to resume rate hikes sooner and more aggressively than expected, leading to a sharper economic slowdown and greater market volatility.

Original source: Bloomberg Markets. For information only, not investment advice.