Weak July Jobs Report Cuts Fed September Hike Odds to 44%

The July jobs report cut market odds of a September Fed hike to 44 percent, shifting the decision to next week's CPI print.

The Fed's path to a September hike narrowed after the U.S. economy shed 23,000 jobs in July, cutting market-implied odds of a rate increase to 44 percent and putting next week's inflation report at the center of the decision.

"Today's weak payrolls print may ease the pressure on the Fed to raise rates at its September meeting, but next week's inflation data will still likely be the deciding factor," said Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management.

Futures markets repriced quickly. CME FedWatch showed a 60 percent probability the Fed holds rates at 3.50-3.75 percent in September, up from 45 percent on Thursday, while traders on prediction platform Kalshi put the hold odds at 65 percent. The 2-year Treasury yield fell to about 4.20 percent and the 10-year to 4.65 percent, the dollar index dropped to 99.50, and EUR/USD rose to $1.1570.

The stakes are high because three Fed officials dissented at the July meeting in favor of a hike, and a hotter CPI or renewed energy shock could revive those calls. The July CPI report lands Wednesday, Aug. 12, with economists expecting headline inflation to slow to 3.4 percent and core to 2.5 percent.

Payrolls Miss Masks a Weaker Labor Market

The Labor Department's report showed nonfarm payrolls fell by 23,000 in July against the 80,000 additions economists polled by Reuters had expected. Revisions deepened the weakness: May job growth was cut to 63,000 from 129,000 and June to 20,000 from 57,000, removing 103,000 jobs from prior estimates.

The unemployment rate ticked down to 4.1 percent from 4.2 percent, but for the wrong reason. The labor-force participation rate dropped to 61.4 percent, the lowest in more than five years, as workers stopped looking for work. Local government education lost 50,000 jobs and retail 19,000, while healthcare added 22,000, below its year-ago monthly average. Average hourly earnings rose two cents, with annual wage growth easing to 3.2 percent.

The softness complicates the case for tightening. Richmond Fed President Thomas Barkin said the report was consistent with his view of the labor market as neither loose nor tight, but Omair Sharif, president of forecasting firm Inflation Insights, cautioned that Fed officials have recently signaled the breakeven pace of job gains is fairly low, which could temper how much weight they put on the miss.

CPI Becomes the Deciding Catalyst

Inflation remains above the Fed's 2 percent target even as it cools. Headline CPI fell to 3.5 percent in June from 4.2 percent in May, and core eased to 2.6 percent from 2.9 percent. The personal consumption expenditures price index, the Fed's preferred gauge, was up 3.7 percent year on year in June.

Energy is the wildcard. Brent crude closed Friday at $85.29 a barrel, volatile on unresolved U.S.-Iran tensions after signs of a shipping deal between Iran and Oman emerged over the weekend. Iran said any agreement may not automatically reopen the Strait of Hormuz, keeping oil prices unpredictable and energy inflation elevated at 15.5 percent in June.

The Cleveland Fed's nowcasting model points to July headline and core inflation of about 3.42 percent and 2.52 percent, respectively. A print near or below those levels would reinforce the case for a September pause, while an upside surprise could hand the three dissenting officials the evidence they need.

Rate Divergence Lifts EUR/USD

The repricing has narrowed the interest-rate spread between the U.S. and the eurozone. The ECB held its deposit rate at 2.25 percent in July after a June increase, with markets still pricing a high chance of another hike in September. Lower U.S. Treasury yields have reduced the dollar's yield advantage over the euro.

EUR/USD holds a bullish structure above 1.1360 support, having rebounded from 1.1390 in late July. Resistance sits at 1.1626, and a break above that level could open a move toward 1.1780 and 1.192. The dollar index, testing its 200-day moving average near 102, continues to trend lower.

The next move in the pair depends on the CPI outcome. Cooler inflation would support a Fed pause and another ECB hike, boosting EUR/USD; a hot print would revive hike expectations and support the dollar. Even after the jobs report, CME FedWatch still prices a 55 percent chance of a hike in October and almost 75 percent in December, leaving the tightening cycle far from settled.

This article is for informational purposes only and does not constitute investment advice.