ECB and BoC cut rates as Fed faces mixed labor market signals

Conflicting signals in the labor market

Since the beginning of last week, all signs pointed to a cooling labor market. On Tuesday, April’s job openings fell to a three-year low of 8.10 million, below the market’s 8.40 million forecast. On Wednesday, the ADP National Employment Report, tracking private-sector hiring, revealed that U.S. businesses added 152,000 jobs in May, marking the smallest increase this year — another sign of a cooling labor market. However, these signs of cooling were short-lived. On Friday, the U.S. jobs report showed stronger-than-expected hiring in May, with employers adding 272,000 jobs for the month, far exceeding the 190,000 forecast. Average hourly earnings also beat expectations, rising 4.10%.

A mixed signal within Friday’s jobs report was unemployment. Unemployment rose from April’s reading of 3.90% to 4.00% — the first time in more than two years unemployment hit 4.00%. This uptick is not surprising as more people tend to enter the labor force during this time of year after school ends. The data readings from the U.S. jobs report bring unwelcome news to the Fed. The Fed wants hiring to slow, continued low unemployment, and wages to return to pre-pandemic levels to alleviate some of the upward pressure on inflation. The Friday reading only reinforces expectations that the Fed will hold rates at this week’s meeting.

An inflection point in monetary policy

Last week, a divergence in interest rate policy decisions occurred. On Wednesday, the BoC announced a quarter-point rate cut from 5.00% to 4.75%, leading the charge of G-7 economies in rate cuts. BoC Governor Tiff Macklem stated that if inflation continues to cool and head “sustainably” towards its 2.00% target, then it is “reasonable to expect further rate cuts.” Macklem made it clear that they are evaluating interest rate decisions “one meeting at a time.” On Thursday, the ECB followed suit, cutting their policy rate a quarter percentage point to 3.75%. This was its first rate cut in almost five years. While inflation has come down, like the U.S., wage growth remains elevated, and inflation is still relatively far from its 2.00% target. In fact, the ECB also announced a revision in its previous estimates of eurozone inflation in 2024 and 2025. Now inflation expectations are at 2.50% and 2.20% compared to 2.30% and 2.00%, respectively. Markets are viewing the ECB decision as a “cautious cut” with little expectation of the Central Bank cutting rates again in July or even September.

While these G-7 economies made their first step in cutting rates, the Fed is expected to hold rates steady at this week’s FOMC meeting. According to the CME FedWatch Tool, the market does not predict a rate cut until September or November of this year. Much uncertainty already surrounds those fall meetings due to the impending U.S. election, and now with the strong jobs report, markets are less certain of a rate cut in September.

FX implications on the divergence of monetary policy rate

If the Canadian and European central banks cut rates while the Fed continues to hold, this could weaken the Canadian dollar and euro against the dollar. This would make imports more expensive and put further pressure on Eurozone and Canadian inflation — hindering the further loosening of interest rate policy. However, strains on any currency could lessen if more central banks cut rates and the Fed continues to hold. Following the interest rate cut decisions, the Canadian dollar weakened only slightly against the U.S. dollar on Wednesday. The euro rose after the ECB raised inflation forecasts following its rate cut on Thursday.

Markets react to mixed data

In response to the cooling labor market data at the start of the week and the ECB and BoC rate cut decisions, rates were down overall last week from the week prior. Notably, one-month term SOFR swap rates, effective on 6/30/24 with five- and 10-year tenors, dropped about 30 basis points in the span of a week on Wednesday. Rates reversed on Friday with the stronger-than-expected U.S. jobs report. Ten-year treasury yields climbed above 4.40% following the release, after trending downward for six consecutive days. The dollar also saw large gains.

Although the forward curve is no longer highly inverted, corporates can still lock in a lower fixed swap rate by forward starting their effective date relative to entering into a fixed-rate swap effective today.

The week ahead

All eyes will be on the Consumer Price Index data release just hours before the FOMC decision this Wednesday. The Fed will update its economic and rate projections at the meeting, communicating its overall outlook for the year and beyond.