Post NFP Call

Employment Data Summary (BLS Report, July 2):

• Non-farm payrolls missed consensus, featuring meaningful downward revisions.
• The decline was partially driven by a one-off 61,000 drop in leisure and hospitality in the May print, attributed to seasonal factors.
• Current three-month average non-farm payroll growth remains at 111,000, significantly above the strategists' estimated breakeven of 20,000.
• The unemployment rate fell to 4.2%, but this was driven by a sharp reduction in labor force participation rather than net job creation.
• Labor force participation dropped from 61.8% to 61.5%; strategists note the rate would have been 4.2% had participation remained at 61.8%.
• The Federal Reserve currently projects year-end 2026 unemployment rates between 4.3% and 4.4%.

Federal Reserve Policy Implications:

• The data eliminates immediate urgency for a July rate hike, reducing market expectations from 8 basis points to 5 basis points.
• Total priced-in Fed hikes over the next 12 months declined from 45 basis points to approximately 37 basis points.
• Strategists maintain that inflation remains the primary driver for future hikes, not just labor market acceleration.
• A September hike remains a plausible scenario if core PCE inflation stays near 3.3% and unemployment remains at or below SEP projections.
• The Fed views the unemployment rate as its core metric for supply-demand balance; the current 4.2% level is already below year-end forecasts.

Fixed Income Market Reaction (Rates):

• The yield curve experienced a bull steepening, with the 2-year yield falling roughly 4 basis points while the 10-year yield remained flat.
• Strategists view the market move as a "reasonable" adjustment rather than a massive overshoot, citing the need for the Fed to assess incoming data.
• Future front-end rates could move higher if inflation remains sticky or if the labor market shows unexpected strengthening.
• A "flatter curve" is anticipated if market pricing of Fed hikes is deemed insufficient by investors.

Macroeconomic Outlook:

• The US economy is characterized by robust investment, particularly in the tech and AI sectors, and resilient consumer spending despite oil price shocks.
• The US is expected to remain a relative macroeconomic outperformer compared to other G10 nations.
• European, Canadian, and Australian economies face headwinds, with weaker growth projections limiting their ability to sustain high rates.
• Canadian economic outlook is further strained by prolonged uncertainty regarding USMCA trade negotiations.

Foreign Exchange (FX) and Dollar Strategy:

• The US Dollar fell approximately 0.5% post-report, consolidating off immediate lows.
• Positioning played a significant role in the move, with hedge funds holding net long dollar positions reaching multi-decade highs entering the release.
• "Real money" investors remain neutral, suggesting the directional pullback was amplified by speculative positioning rather than fundamental revaluation.
• Bank of America's base case remains for the Dollar to strengthen through the summer, supported by higher relative US rates.
• The case for rate hikes in other G10 currencies is waning due to falling oil prices and lower headline inflation, creating a relative dollar advantage.

Forward-Looking Catalysts:

• Upcoming ISM services data is scheduled for release next week.
• Further inflation readings are expected in the middle of the month, which will determine if July hikes are revisited or if the September path holds.
• Continued sticky inflation or stronger-than-expected labor data could increase the pace of Fed hiking pricing.