US NFP and how the market could react

Tomorrow has the all-important release of US labor market numbers. But the Fed's Powell kind of already robbed the thunder from the release during his speech at the Brookings Institute yesterday. He basically implied that the Fed would start slowing down its tightening at the next meeting. Naturally the market jumped and the dollar weakened in response. Now the question is whether there will be follow-through on the optimism with the jobs numbers.

November's NFP is expected to come in lighter compared to the prior month, but it should be noted that the data has been markedly outperforming expectations lately. Taken in context of the latest BLS report showing that the labor market remained tight, the consensus for what to expect out of NFP has drifted up, slightly. A week ago, analysts were forecasting 200K jobs added, but that has now moved up to 210K jobs, compared to 261K in October.

The trends remain favorable

Prior to covid, a 210K jobs report would be considered relatively good. But referring back to the BLS report that came out yesterday, there are some worrying signs. As mentioned, in October there were 261K jobs created, but 353K jobs went off the market. Meaning that companies are closing down job offers faster than people are being hired. The largest drop in job offers occurred in state and local governments, followed by manufacturing. Combined, that represented the bulk of the reduction in job openings.

For now, the market remains tight, mostly because the extraordinarily large gap between job openings and jobseekers that occurred from the pandemic is still there. There were 6.1 million people looking for work last month, but there were 10.3 million jobs for them. Despite this mismatch, wages have failed to keep up with inflation. Current expectations are that average hourly earnings will slow to 0.3% from 0.4% reported in October.

Putting the pieces together

The Fed's main worry though this cycle has been that higher inflation combined with an extremely tight labor market would lead to a wage-price spiral. However, that hasn't happened, giving the Fed plenty of space to raise rates to combat inflation. Recently, inflation has been starting to come down, from a combination of higher borrowing costs and worries about an impending recession.

The prolonged loss of purchasing power among American workers as their salaries fail to keep up with prices would be expected to lead to demand destruction. Which would also contribute to reducing inflation, as Americans see their pocketbooks being pinched and refuse to pay higher prices. As retailers across the country report rising inventories and some are suspending buying new inventory for the start of next year, the natural expectation is that the economy will slow down. Which in turn also contributes to lower inflation.

The unemployment rate is expected to remain steady at 3.7%, and so is the participation rate. This is reflected in the BLS data showing the number of people quitting to find better pay far outweighed the number of people being fired.