Editor's Note: On September 4, the US Bureau of Labor Statistics will release the August employment report. This is the final monthly nonfarm payroll data before the Fed's September 15-16 interest rate decision and a key window to assess whether the US labor market continues to cool.

In July, nonfarm payrolls unexpectedly decreased by 23,000, with May and June data subsequently revised down by a combined 103,000, indicating that the actual momentum of job growth is weaker than previously estimated. At the same time, US inflation remains significantly above the 2% target, and Fed Chair Powell's comments after the Jackson Hole speech have led the market to reassess the likelihood of a September rate hike.

Capital Street FX believes that the core contradiction in the market this week has shifted from "Will the Fed remain hawkish?" to "Can the slowdown in employment offset inflationary pressures?" JOLTS Job Openings, ADP Employment, ISM Price and Employment sub-indices will provide preliminary signals for Friday's nonfarm payroll report, but what will truly impact policy expectations may not just be the net job additions but also the labor force participation rate, wage growth, and revisions to prior figures.

Nonfarm payrolls still cannot provide the final answer for September policy. The US will release the August PPI and CPI before the interest rate meeting, so more accurately, this report will determine whether the evidence on the employment side is sufficient to deter a rate hike, while inflation data still holds the final piece of the pricing puzzle.

The following is a translation of the original text:

In the first week of September, the US market will see a dense set of economic data releases: JOLTS Job Openings and ISM Manufacturing Index on Tuesday, ADP Private Employment and Fed Beige Book on Wednesday, ISM Non-Manufacturing Index on Thursday, and the August nonfarm payroll report on Friday.

These data releases will revolve around one central question: With inflation still elevated, has the US labor market weakened enough to keep the Fed on hold?

Currently, there is a clear divergence in the market regarding the Fed's September policy path. Powell emphasized in the Jackson Hole speech that if inflation does not clearly and swiftly return to 2%, the Fed will need to take further action. Market pricing cited by Capital Street FX shows that the probability of a 25-basis-point rate hike in September increased from about 35% to 57% after the speech.

Meanwhile, interest rates adjusted in sync with asset prices: the 2-year U.S. Treasury yield rose by 6.6 basis points to 4.29%, the U.S. dollar index increased by 0.55%, and gold and Bitcoin both fell by around 3.2% and 3.4%, respectively. These movements indicate that the market is pricing in higher short-term rates into the U.S. dollar, precious metals, and crypto asset prices.

Whether this round of hawkish pricing can be sustained remains to be seen and will depend on this week's employment data.

Weak Surface in Nonfarm Payrolls, Revised Data Signals Stronger

In July, U.S. nonfarm payrolls decreased by 23,000, significantly below the market's original expectation of an increase of about 83,000. Government employment decreased by 53,000, while the private sector added 30,000 jobs. More significantly, the newly added jobs in May and June were revised down by a total of 103,000, reducing the recent three-month average job growth to about 20,000.

The U.S. Bureau of Labor Statistics has confirmed that the August employment report will be released on September 4th at 8:30 a.m. ET.

Looking at the unemployment rate, the data for July does not seem poor: the unemployment rate fell to 4.1%, a 13-month low. However, this partial improvement is related to the labor force participation rate dropping to 61.4%. In other words, the decrease in the unemployment rate does not entirely represent strengthened employment demand, as part of the reason is the increase in the number of people exiting the labor market.

The year-over-year growth rate of average hourly earnings also slowed to 3.2%. If wage growth continues to decline, employment remains weak, and the data from previous months are revised downward again, the market may further reduce expectations of a rate hike in September.

Therefore, Capital Street FX believes that what is most worth observing on Friday may not only be the addition of nonfarm payrolls. The labor force participation rate, wage growth, and historical data revisions can better reflect the underlying changes in the labor market.

This assessment needs to be approached with caution. Monthly nonfarm data is volatile, and a single month of negative growth may be influenced by government sectors, industry structures, and seasonal adjustments. Only when weak employment, wage slowdown, and downward revisions occur simultaneously, can more complete evidence be provided for a sustained cooling of the labor market.

Three Sets of Data to Provide Clues for Friday's Employment Report

Prior to Friday, the market will receive three sets of relevant indicators.

First is the July JOLTS Job Openings report released on Tuesday. Job openings reflect unfilled labor demand by businesses, and if the number of openings continues to decline, it usually indicates a decrease in labor market tightness. However, JOLTS data has a lagging nature, and a decrease in job openings does not necessarily mean that companies are starting large-scale layoffs.

Wednesday's ADP Employment Report will provide insight into private sector hiring. Due to differences in scope and methodology between ADP and the official nonfarm payrolls survey, short-term trends may exhibit significant divergences. Therefore, ADP should not be directly interpreted as a forecast for nonfarm payrolls. However, if the data significantly surpasses or lags behind expectations, it may still prematurely impact market positioning.

The ISM Manufacturing and Services Index, released on Tuesday and Thursday, respectively, will offer clues on growth, employment, and inflation. The July ISM Manufacturing Index stood at 55.6, reaching its highest level since May 2022; the employment sub-index rose to 52.8, reentering expansion territory. The ISM Services Index was at 54.1, but the employment sub-index was only at 47.4, indicating ongoing expansion in services activity alongside a contraction in employment demand.

Compared to the composite index, Capital Street FX pays more attention to the Prices Paid sub-index. The July ISM Services Prices Paid Index reached 70.3, suggesting persistent cost pressures for businesses. If the price sub-indices remain elevated this week, even with a slowdown in employment, the Federal Reserve may find it challenging to entirely ignore inflation risks.

The resulting combination may be more crucial than the nonfarm payroll figures themselves: a decline in employment and easing price pressures would reinforce the pause-in-rate-hike logic; resilient employment and elevated price sub-indices could solidify market rate hike expectations; if both employment and prices weaken simultaneously, US bond yields and the US dollar may face more pronounced downside pressure.

The core of market trading is how the Fed's "reaction function" evolves

The so-called policy reaction function refers to the market's assessment of under what conditions the central bank would take policy action based on variables such as economic growth, employment, and inflation.

Chair Jerome Powell's Jackson Hole speech altered the market's short-term understanding of this reaction function. He emphasized that the 2% inflation target remains steadfast and suggested that current financial conditions do not yet qualify as significantly tight. This led investors to reconsider: as long as employment does not deteriorate rapidly, is the Fed still likely to further hike rates to curb inflation.

At the July rate-setting meeting, the Fed voted 9-3 to maintain the federal funds target range at 3.50% to 3.75%; three dissenters leaned towards a 25-basis-point hike. The meeting minutes also indicated that the Committee believed economic activity was still steadily expanding, with inflation relatively overshooting the 2% target.

In this context, the significance of August's nonfarm payroll report lies not in solely determining whether the Fed will hike rates but in altering the evidence threshold for a rate hike.

If employment data shows pronounced weakness, the Fed will face a clearer dual constraint: further rate hikes may hasten the cooling of employment, while keeping rates unchanged could sustain inflation persistently above target. Conversely, if employment continues to expand and wage growth remains resilient, policymakers will have more leeway to prioritize tackling inflation.

Non-Farm Payrolls May Affect Rate Hike Probability, But CPI Awaited for Final Confirmation

The original article referred to this week's employment report as the "final verdict" before the September rate hike meeting, but this statement needs to be toned down.

According to the official schedule, the Fed will hold its rate hike meeting on September 15th and 16th; the August PPI and CPI data will be released on September 10th and 11th, respectively. Therefore, the Non-Farm Payrolls report is the final comprehensive monthly employment report before the meeting, but not the last set of important economic data.

Next, three confirming signals can be observed:

First, whether the non-farm payrolls continue to show close to zero growth or turn negative, and whether the previous figure is significantly revised downwards again.

Second, whether the labor force participation rate and wage growth weaken simultaneously. If the decline in the unemployment rate is mainly due to a drop in the participation rate, the labor market may not be as robust as it seems on the surface.

Third, whether the subsequent CPI data confirms a easing of price pressures. Even if the non-farm payrolls disappoint, if core inflation once again exceeds expectations, the market may still retain its pricing for a rate hike.

For the asset markets, weak employment data may depress short-term Treasury yields and the dollar, providing breathing room for gold, bitcoin, and other assets sensitive to real interest rates; strong employment combined with high inflation may push short-term rates higher. However, these are just market conjectures based on current policy pricing, and the actual response depends on the deviation between data and expectations, as well as investors' previous positioning.

Therefore, the true question answered by Friday's non-farm payrolls is not whether the Fed will definitely hike rates in September, but whether the labor market has weakened enough to constrain its room for rate hikes. The final answer still awaits next week's inflation data.

Welcome to join the official BlockBeats community:

Telegram Subscription Group: https://t.me/theblockbeats

Telegram Discussion Group: https://t.me/BlockBeats_App

Official Twitter Account: https://twitter.com/BlockBeatsAsia