Market Brief: Traders Hunker Down Ahead of Non-Farm Payrolls

Trading ranges are shrinking and short-term volatility gauges are pointing to turbulence ahead as currency market participants move to the sidelines in the run-up to tomorrow’s all-important non-farm payrolls report. Traders expect a modest slowdown in hiring and a steady unemployment rate, but uncertainty is high, and the implications for the Federal Reserve’s policy trajectory are significant. The dollar is almost unchanged, ten-year Treasury yields are inching higher after tumbling in yesterday’s session, and equity futures are pointing toward almost-imperceptible gains at the North American open.

The European Central Bank cut its benchmark rates by a quarter point – as had been expected – but lowered its forecasts for inflation and economic growth over the next year in a sign that it could ease policy further in the coming months. In the official statement setting out the reasoning behind the central bank’s eighth rate cut in a year, policymakers said “While the uncertainty surrounding trade policies is expected to weigh on business investment and exports, especially in the short term, rising government investment in defence and infrastructure will increasingly support growth over the medium term”. Updated projections show headline inflation is now set to average 2.0 percent this year, before falling to a below-target 1.6 percent in 2026 and 2.0 percent in 2027, while the economy is seen expanding by less in 2025 than previously expected. Markets are responding with a modest upward revision in the odds on another two rate cuts this year, while the euro is holding broadly steady relative to pre-release levels.

Policy settings have played an increasingly marginal role in influencing the euro’s direction in the last three months. Instead, optimism surrounding Germany’s fiscal stimulus plans, a sharp downgrade in views on the US economy, and a slower-moving reallocation away from American capital markets have driven the common currency to a 10-percent gain this year. We have reservations – mostly derived from what US Treasury Secretary Scott Bessent likes to call Europe’s “collective action problem” – but markets are overwhelmingly bullish on the currency, with the difference between one-month and one-year risk reversals pointing to a sustained advance in the year ahead.

Long-term yields fell yesterday as the US published a series of negative data releases. Automatic Data Processing (ADP) said private sector employment grew at its slowest rate since early 2023 last month, with just 37,000 jobs added against an expected 115,000. The Institute for Supply Management’s measure of services-sector activity (which covers a far wider swath of economic activity than its manufacturing counterpart) fell back into contractionary territory, undershooting expectations for a continued expansion as businesses reported a stagflationary combination of price increases and plunging new orders. The Fed’s Beige Book survey – Jerome Powell’s favoured read on underlying economic conditions – was overwhelmingly tariff-flavoured, with most businesses reporting weaker investment and hiring plans amid elevated uncertainty. And the New York Fed released survey results showing that manufacturers experienced an average 20-percent increase in tariffed goods prices over the last six months, while services businesses saw a 15-percent increase. Although “almost half of businesses reported a decrease in their bottom lines,” only a quarter of respondents fully absorbed the hit, with most passing along higher costs to consumers.

Worries about the US fiscal situation also intensified, imperilling the Trump administration’s “big beautiful bill” as it makes its way through Congress. A day after Elon Musk called it a “disgusting abomination”, the non-partisan Congressional Budget Office said it expects the legislation to add $2.4 trillion to US deficits between now and 2034, adding to an already-spectacular imbalance between government incomes and expenditures, and driving a continued rise in overall indebtedness. It’s difficult to know how this might impact the likelihood of the bill’s passing, but it remains unwise to bet against US politicians voting in favour of fiscal conservatism, and it seems likely that this will add to the mountains of issuance that bond markets are forced to absorb from the world’s major economies in the coming years.

Here in Canada, markets are looking relatively placid after the Bank of Canada delivered an as-expected rate decision yesterday. Policymakers led by Tiff Macklem left borrowing costs unchanged while signalling a willingness to ease policy further in the coming months if price expectations remain well-anchored and the economy displays signs of further weakness. Options traders see the loonie grinding incrementally higher over the remainder of the year as the US economy underperforms and the Fed returns to its rate-cutting path, but “tail risks” remain significant, and this view could be challenged by a resurgence in the greenback or a more prolonged downturn in Canada.

*This projection assumes no additional tariff revenues, but also assumes that tax cuts under the Big Beautiful Bill Act will expire in 2028. A separate analysis from the non-partisan Yale Budget Lab suggests that government revenues could rise by $2.381 trillion by 2034 under the current tariff regime (before substitution effects), but if tax cuts are rolled over before expiry, the gap would expand by $4 trillion over the same time frame, leading to a net $1.4 trillion revenue shortfall.

**Apologies for the length of today's piece. As Mark Twain put it, "I didn't have time to write a short letter, so I wrote a long one instead".

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