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The US labor market has become the critical variable determining whether the Federal Reserve cuts rates and, by extension, whether markets rally or stumble. Wednesday's nonfarm payroll report will test whether the apparent softening in hiring is the start of a broader employment deterioration or an anomaly in otherwise stable conditions.
The stakes are high. Market participants have already priced in expectations of Fed rate cuts based on weakening labor data. Swap rates reflecting Fed policy expectations have fallen 12 basis points following the Fed's recent decision, with the market pricing in the equivalent of an additional half-rate cut. A June cut is fully priced in, while an April reduction stands at even odds.
But the underlying employment picture presents conflicting signals that will likely dominate Fed deliberations heading into Wednesday's release.
On one hand, hiring has clearly slowed. Private sector hiring rates are significantly diminished compared to pre-pandemic levels. Job openings declined sharply in January, a crucial factor in the market's pivot toward expecting a more accommodative Fed stance. The "professional and business services" sector has seen a marked decline in hiring rates. Announcements of job cuts reached their peak in January, marking the highest level since 2009.
Consumer expectations suggest deeper anxiety. University of Michigan surveys show the percentage of Americans anticipating an increase in unemployment is now at levels comparable to those seen during the financial crisis.
Yet separations remain low. There are hardly any individuals being let go or choosing to exit their positions voluntarily. That divergence – declining job creation but stable employment – is unusual and complicates the Fed's assessment of labor market health.
"The current landscape of the US jobs market presents a rather unique scenario," BRN said in a research note. The hiring decline may also appear worse than it actually is due to benchmark adjustments expected this week, which could lower hiring estimates for the year ending March 2025 by 60,000 to 70,000 per month.
The disconnect between job postings and unemployment is narrowing. Vacancies have declined while unemployment remained relatively stable, but the correlation between the two is stabilizing. Last week showed a rise in the unemployment rate alongside a decline in job opportunities—a shift that signals potential labor market deterioration.
Fed Chair Jerome Powell has adopted a more lenient stance regarding the employment landscape, echoing language that suggests policy is well-positioned. But the latest data suggests caution is warranted. The central bank faces a dilemma: Is the recent softening in employment a byproduct of productivity gains from artificial intelligence, or a genuine warning signal that demand is cooling?
Artificial intelligence has been cited in less than 10% of announced job cuts, and even those attributable to AI may represent convenient explanations rather than fundamental shifts. Yet the concentration of hiring declines in professional services – the sector most exposed to AI disruption – raises questions the Fed cannot ignore.
What happens Wednesday will reverberate across asset classes. Equity markets have already factored in expectations of easier Fed policy, with hedge funds showing net selling of US shares for four consecutive weeks – the highest rate since Trump's 2024 trade war. Bitcoin has fallen roughly 50% from its peak but has recovered some ground, with recent volatility reflecting broader market uncertainty about the Fed's path.
Recent anxiety over AI's impact on US economic growth and employment has weighed on risk assets. But a Fed rate cut cycle would likely benefit cryptocurrencies, as it did last year. The question is whether the employment data on Wednesday convinces policymakers that cuts are necessary, or whether Fed officials believe the slowdown is temporary and policy should remain steady.
"The payroll figures will be crucial to defining the underlying factors at play," BRN said, noting that the research firm expects unemployment to hold at 4.4%, but emphasis will fall on revised benchmarks and the forward hiring trajectory rather than the headline number.
A disappointment – fewer jobs created than expected – would validate market expectations of Fed easing and likely support risk assets including crypto. A surprise to the upside would force a reassessment and could spark a selloff in markets currently pricing in rate cuts.
Either way, the employment report has become the single most important near-term catalyst for market direction.
