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US July jobs report shifts consensus towards a 75bp Fed hike in September

USD: Defying all the signs of deceleration in other US labor market data, July’s non-farm employment jumps by 528k, well above consensus for a 250k rise with private hiring up 471k with 402k in services. The unemployment rate unexpected falls to 3.5%, due to a 179k increase in employment in the household survey (after a 315k decline last month) and a slight decline in the labor force participation rate, falling from 62.2% to 62.1%. Weekly hours are also revised up to 34.6 from 34.5 in June and stay there in July and the total hours worked post the largest monthly gain this year. Meanwhile average hourly earnings rise 0.47%MoM (to 5.2% YoY versus consensus for 4.9%YoY), consistent with other wage measures like the Atlanta Fed Wage Tracker and ECI which have been stronger. But the headline jobs numbers themselves seem to be at odds with measures from the ISM and PMI report released earlier last week. That said, the data is almost uniformly strong across industry categories which confirms there was no US “recession” in Q1 and Q2 of this year.  
 
USD: However, the strength of this year’s employment gains should be seen in the context of the severe volatility of the past few years. July is the first month in which total US employment has decisively risen above pre-COVID levels. Gains in 2022 have been strong, but this follows multi-million person swings dating back to 2020. Of course, July is a seasonal transition period for the US economy with net hiring before seasonal adjustment actually down, as usual (-385,000). Changing seasonal patterns have caused downward distortions in the summer months in the past, and Friday’s data may reflect the “correction” for this.  However, the clearer and more important message for now is that there have only been strong gains in employment over the course of 2022 so far (+470,000 on average).
 
USD: The strong jobs reading is particularly surprising given some signs of nascent loosening seen in the ISM reports released earlier last week and falling job openings (down by 1.2 million over the course of 2Q) as well as recently rising initial jobless claims. But for now, the payrolls data should stifle views that the US was, or is, in a recession. Unfortunately though, the history of employment data shows zero lead time on average between periods of rising employment and the onset of new recessions and the current rising business inventories and rising gross layoffs may already be indicative of a coming transition to less-strong labor market readings. However, the Fed’s likely response to Friday’s strong employment data will likely be to stay on its rapid tightening track for the September meeting at least (short rates have already moved to fully price in another 75bp Fed rate increase in September).
 
Evidence of softening demand raises risk of sooner dovish pivot from BoC than Fed
 
CAD: Canadian employment falls by -30.6k jobs in July, contrary to Citi analysts’ expectations for a +30k rise and consensus for +15k but with the unemployment rate still at a low 4.9% as the participation rate declines to 64.7% from 64.9%. Hourly wages of permanent employees also rise by less than last month at 5.4%YoY compared to 5.6%YoY in June and versus expectations for a 5.9% increase. Citi analysts note details of the July report are broadly weaker compared with last month.
 
CAD: In June, the combination of falling employment alongside declines in the unemployment rate and participation rate plus strong wage growth seem to have suggested labor supply shortages as the main issue driving weaker headline employment figures. In July however, there are more signs that weaker employment figures are a result of softening demand. While the unemployment rate still remains low, much softer than expected wage growth would argue against labor supply being the main factor driving softer employment growth. That said, Citi analysts do not expect the BoC to shift towards a more dovish stance just yet and expect the BoC will hike by 75bp in September. However, the softening in activity data supports expectations for a somewhat sooner dovish pivot from the BoC compared to the Fed.
 
More rates flexibility implies RBA is prepared to let economy run “hotter” than peers
 
AUD: RBA’s August statement of monetary policy (SMP) released Friday, sees upward inflation and downward growth revisions for Australia. Year-end GDP growth is revised down from 4.2% to 3.2% from the technical assumption of a higher cash rate and its impact on private spending and housing market activity while the GDP downgrade for 2023 is far less, from 2.0% to 1.8% (but still lower). Meanwhile. headline CPI for 2022 is revised up from 5.9% to 7.8%, partly due to large increase in household energy costs of around 10% to 15% in H2’2022. Inflation in then forecast to ease although the higher base means that it remains above the top of the target band (2-3%) until December 2024, six months later than the previous forecast. The unemployment rate is forecast to fall to 3.4% in December 2022 before rising slowly to 4.0% by the end of 2024.
 
AUD: RBA’s GDP forecasts are around 0.5pp lower than Citi analysts’ forecasts out till the end of 2023. Citi analysts also expect inflation to peak earlier at 7.1% in Q3 2022 but to remain around this level until year-end before moderating to 3.5% by the end of 2023. This puts Citi’s CPI profile on a faster downward trajectory than the RBA. Meanwhile, the RBA’s forecast increase in the unemployment rate shows the labor market remaining at or above full employment over the forecast horizon. This partly explains the steady increase in wage costs that are forecast to move from 3.0% at the end of 2022 to 3.9% at the end of 2024.
 
AUD: Implications for monetary policy - the new RBA forecasts complement recent statements that introduce some flexibility in future monetary policy decisions by suggesting the RBA is not on a ‘pre-set’ path. More importantly, while some central banks, notably the Fed, BoC and RBNZ have signaled a willingness to sacrifice some activity in pursuit of tackling high inflation, the RBA appears to give more weight to minimizing output losses. This suggests the RBA is prepared to let the economy run a little hotter which could see the Bank reduce the size of its rate hikes. However, given the large upgrade to inflation forecasts and upside risks to wages, there still remain hawkish risks on the horizon. Overall, Citi analysts still see the year-end forecast for the RBA cash rate at 2.6% (+50bp hike in September and a further +25bp rise in November), followed by two more +25bp hikes in February and March next year with a terminal of 3.1% that is slightly above the RBA’s “neutral policy rate range” of around 2.5%-3%, but below the market’s pricing of the RBA terminal rate of between 3.25-50%.
 
Week Ahead - focus shifts to US inflation data after solid July jobs report last week
 
USD: US July CPI MoM – Citi: 0.2%, median: 0.2%, prior: 1.3%; CPI YoY – Citi: 8.8%, median: 8.8%, prior: 9.1%; CPI ex Food, Energy MoM – Citi: 0.5%, median: 0.5%, prior: 0.7%; CPI ex Food, Energy YoY – Citi: 6.1%, median: 6.1%, prior: 5.9% - Citi analysts expect a 0.52%MoM increase in core CPI in July, a softer increase than 0.7% in June but with still-strong underlying details, in particular shelter prices. Services prices may also  pick up, largely reflecting months of consistently strong wage gains amidst a still-tight labor market. Meanwhile, the pullback in headline CPI from 9.1%YoY in June could suggest peak” of inflation is reached.
 
USD: US July PPI Final Demand MoM – Citi: 0.3%, median: 0.3%, prior: 1.1%; PPI Final Demand YoY – Citi: 10.6%, median: 10.4%, prior: 11.3%; PPI ex Food, Energy MoM – Citi: 0.5%, median: 0.5%, prior: 0.4%; PPI ex Food, Energy YoY – Citi: 7.7%, median: 7.7%, prior: 8.2%; PPI ex Food, Energy, Trade Services MoM – Citi: 0.2%, median: 0.5%, prior: 0.3%; PPI ex Food, Energy, Trade Services YoY – Citi: 5.8%, median: 5.9%, prior: 6.4% - producer prices should rise a modest 0.3%MoM in July, much softer than the 1.1% increase in June due largely to a decline in energy prices. Core goods prices in PPI should also continue to slow due to easing goods demand and falling commodity prices.  
 
USD: US August University of Michigan Sentiment – Citi: 50.9, median: 52.0, prior: 51.5, University of Michigan 1Yr Inflation Expectations – Citi: 5.1%, median: NA, prior: 5.2% - Citi analysts expect a modest decline in the University of Michigan consumer sentiment index to 50.9 in August but with balanced risks. Recession risks are more widely expected among businesses and consumers but with consumer prices and retail gas prices falling, this could also lead to further declines in inflation expectations, particularly the 1-year ahead measure. However, it is the 5-10 year inflation expectations that is key - while risks for longer-term inflation expectations are likely similarly tilted towards the downside, a further climb back towards 3% would be hawkish.
 
JPY: Japan’s Balance of payments (June): Current account balance: Non-seasonally-adjusted: -¥781.8bn, Previous: +¥128.4bn; Seasonally-adjusted: +¥29.4bn, Previous: +¥8.2bn – Citi analysts expect Japan’s current account balance to generate a ¥781.8bn deficit in June before seasonal adjustment and a +¥29.4bn surplus after adjustment (+¥128.4bn and +¥8.2bn, respectively in May). Despite higher real exports thanks to the lifting of lockdowns in China, the trade deficit probably increased in June as surging resource prices likely boosted imports. Meanwhile, the team expects primary income surplus to remain, reflecting a positive rebound of direct investment income following May’s drop, yen depreciation and relatively high overseas interest rates.
 
GBP: UK Q2 GDP will provide the first notable economic touch point following last week’s eventful policy meeting. Citi analysts expect growth to print in line with MPC forecasts of -0.2% QQ (Citi -0.2%, Consensus -0.1%). Some resilience here reflects improvements in net trade which seems to be recovering but private consumption and investment are likely to remain weak with UK growth likely to deteriorate further in the autumn.
 
CNH: China PPI (%YoY) July: Citi Forecast 5.1, Consensus 4.9, Prior 6.1; CPI (%YoY): Citi Forecast 3.0, Consensus 2.8, Prior  2.5 – China’s CPI inflation may further climb to 3%YoY while PPI may moderate to 5.1%YoY in July — the MARA’s agricultural product price index has risen and food price deflation has reversed while services price are supported by the tourist season. However, the NDRC cut  gasoline and diesel prices twice in July and in the industrial space, the PMI index of producer price and purchase price indices marked the lowest reading since 2016, amid the commodity selloff.