A stronger-than-expected US labor market won’t keep the Federal Reserve from pivoting to a series of interest-rate cuts next year, but it could take until May for it to deliver the first reduction, traders bet on Friday.
Employers added 199,000 workers to their payrolls in November, the Labor Department’s monthly jobs report showed, more than the 180,000 that economists had expected, and the unemployment rate unexpectedly fell to 3.7 percent , from 3.9 percent in October.
Hourly earnings ticked up 0.4 percent from a month earlier, more than expected and an acceleration from the prior month. But the labor force participation rate also rose, to 62.8 percent , easing the prospect that an overheated job market will short-circuit progress on the Fed’s inflation battle.
A separate report Friday showed US consumer sentiment improved more than expected in December as households saw inflation pressures easing.
The US central bank is expected to keep rates in the current 5.25 percent -5.50 percent range when it meets next week, leaving policy on hold since July. Traders before Friday’s jobs report had put about a 60 percent probability on a March start to Fed rate cuts, but after the data reduced that to just under 50 percent , with a first reduction seen as more likely to come in May.
Further rate cuts are priced in for the rest of 2024, with the policy rate seen ending the year in the 4 percent -4.25 percent range as the Fed adjusts borrowing costs downward not as an antidote to a weaker labor market but rather to keep pace with an expected continued cooling in inflation.
The pace of that improvement in inflation will help determine the timing of the Fed’s pivot to rate cuts, analysts said.
“We maintain our call for the Fed to start cutting rates by mid-year, but it is contingent on inflation continuing to trend lower and further weakening in economic activity,” wrote Nationwide economist Kathy Bostjancic after the report.
Fed policymakers will release their own views of where the economy, inflation, and interest rates will go next year when they wrap up their last meeting of the year on Wednesday.
Meanwhile, hedge funds look to be scaling down their record short position in US Treasury futures, marking the beginning of the end of the so-called ‘basis trade’ – an unwind that regulators have warned could pose severe financial stability risks.
With the Federal Reserve expected to begin cutting interest rates next year, perhaps as early as March, attention will intensify on the reversal of the lucrative trade for hedge funds when rates were rising.
The basis trade is a relative value trade where hedge funds exploit the small price difference between cash Treasuries and futures contracts.
They “short”, or sell the bond future, and go “long”, or buy the cash bond. The trade is funded in overnight repo markets and highly leveraged.
If the unwind is now underway, the question for authorities – and financial markets at large – is whether the $1 trillion position can be unwound in an orderly manner.
A ‘soft landing’, if you like.
The Bank of England this week was the latest financial authority to warn that a rapid unwind of such a large and highly leveraged position could lead to unwanted market volatility.
“Sharp increases in volatility in market interest rates could lead to increases in margin required on the futures positions, or hedge funds may find it harder to refinance their borrowing in the repo market,” the BoE warned. —Reuters
