Top Strategist: What Would it Take from NFP for a 50 Bps Sep Fed Cut?

With the upcoming release of the non-farm payrolls report, market participants are focused on what it might mean for the Federal Reserve's next move.

As speculation around potential rate cuts intensifies, BMO's star fixed income strategist Ian Lyngen provides insight into what kind of data could warrant a more aggressive cut from the Fed.

Current Market Sentiment: A Weaker Jobs Report Priced In

The bond market is currently positioned for a softer jobs report than consensus forecasts suggest. The market's expectation is for a net gain of 160,000 jobs in Friday's report, with the unemployment rate steady at 4.2%.

However, Lyngen argues that while the outlook for the economy and employment is indeed one of cooling, the current levels in the bond market may be overly pessimistic about the potential for near-term downside in the labor market.

What It Would Take for a 50 Basis Point Cut

The prevailing question in the market right now is: what level of employment weakness would justify a 50 basis point cut in the Federal Funds rate?

According to Lyngen, a payrolls gain of less than 50,000 would almost certainly push the Fed toward this more aggressive stance. Additionally, any reading below 100,000, especially if accompanied by another uptick in the unemployment rate, would likely bring a 50 basis point cut back into the discussion.

BMO has been among those advocating for a 25 basis point cut, yet Lyngen acknowledges that confidence in this baseline scenario has diminished following recent data releases.

The Beige Book’s indication of flat-to-lower economic growth during the intermeeting period has raised red flags. Business leader anecdotes of uncertainty are not typically considered "hard data," but they add to the growing narrative of an economic slowdown.

The report's observations suggest that the forward path of growth is increasingly uncertain, which could influence the Fed's decision-making process.

The Implications of a Consensus Report

If the jobs report aligns closely with consensus — a payroll gain of around 165,000 and a slight drop in the unemployment rate to 4.2% — the outcome would likely prompt a bear flattening in the Treasury market. This scenario would put the onus on upcoming inflation data to make a compelling case for a 50 basis point cut.

Essentially, even if the labor market shows resilience, the broader economic indicators will need to justify a more significant policy shift.

Market Implications and Strategic Considerations

Investors need to be mindful of the nuances involved in interpreting this jobs report. The market's reaction will not only depend on the headline figures but also on underlying details such as wage growth, labor force participation, and revisions to prior months' data.

A lower-than-expected payroll number or an uptick in the unemployment rate could lead to a swift repricing of rate expectations, impacting bond yields and equity markets.

Conversely, if the employment data aligns with consensus or shows only mild deviation, the market focus will quickly shift to next week's inflation data. Stronger-than-expected inflation figures could temper expectations for a deep rate cut, keeping the focus on a 25 basis point reduction instead.

Conclusion

As we head into the release of the non-farm payrolls report, the market remains on edge. With expectations finely balanced between a 25 and 50 basis point rate cut, the economic data over the next week will be crucial in determining the Fed's path forward.

While a weaker jobs report could be the catalyst for a more aggressive rate cut, the data will need to align consistently across employment and inflation metrics to solidify such a move. Investors should prepare for heightened volatility as the market digests each new piece of economic information.