Strong data could become a nightmare for the market—it will provide ammunition for the Federal Reserve's rate hike in December, adding another "rate bomb" amidst the AI trading collapse and aggressive selling by CTA funds.

Written by: Xu Chao, Wall Street Insights

The U.S. October nonfarm employment report will be released on Friday (November 6) at 8:30 AM Eastern Time. The market generally expects the data to rebound from the September low, but the timing of this report is extremely tricky—just the day before the data is released, tech stocks suffered heavy losses, with the Nasdaq 100 index plunging 6.36% in a single day, marking the worst day since March 2020, and AI trading completely fell apart.

The market shock on Thursday has profoundly changed the interpretation framework of the employment report. The S&P 500 index dropped 4.36% in a single day, the Philadelphia Semiconductor Index fell 12%, and the VIX volatility index jumped 11.5 points to 28, indicating a sharp contraction in market liquidity. Against this backdrop, a significantly better-than-expected employment report may not only fail to uplift market sentiment but could also reignite Fed rate hike expectations for December at the worst possible time, adding fuel to an already precarious market.

From the response in the options market, investors are preparing for significant volatility. On Friday, the implied volatility of S&P 500 straddles rose to 1.45%, the highest single-day pricing level since March of this year—while the actual realized volatility of straddles on Thursday was nearly 8 times the pricing.

Data points to a rebound, but divisions remain

The market generally expects that nonfarm payrolls for October will rebound significantly from 29,000 in September. A Bloomberg survey shows that Wall Street predictions range from 35,000 to 131,000, with a consensus expectation of around 65,000. The unemployment rate is expected to remain unchanged at 4.2%, with average hourly earnings projected to rise by 0.3% month-on-month and annual growth expected to drop to 2.9%, falling below 3% for the first time since May 2021.

Goldman Sachs predicts that nonfarm employment will increase by 75,000, which is above consensus expectations, and estimates that the increase in the private sector will be 70,000. The basis for Goldman Sachs' prediction includes: initial claims for unemployment benefits decreased to 195,000 in the October survey week, down from 204,000 in September; JOLTS data showed job openings unexpectedly surged by 333,000 to 7.523 million in September, a new peak for the cycle; ADP private employment increased by 86,000, which is above expectations; Challenger layoff data reported that announced layoffs in October were at 43,994, down 71% year-on-year, the lowest since 2023. From a seasonal perspective, Goldman also noted that when Labor Day falls later in September, employment data typically rebounds in the following October, with a historically average acceleration of about 50,000.

However, there are also voices pointing to downside risks. Data from Revelio, a data services provider, shows that October's new employment was only 26,000, significantly lower than the revised figure of 67,600 from the previous month, representing a clear low end anomaly among the forecasts.

Unemployment rate and wages: Details matter more than headlines

The unemployment rate reading could become a more market-impactful variable on Friday than the total nonfarm figure.

The September unrounded unemployment rate was 4.18%, meaning a very small change could push it to either 4.1% or 4.3%. Goldman Sachs, Turnleaf, and the Chicago Fed all lean towards a downside risk for the unemployment rate, believing it may converge towards a lower level suggested by the continued claims for unemployment benefits. Goldman also pointed out that its "relaxation tracker," which combines ten labor market slack indicators, currently stands at 4.6%, "indicating the labor market is actually weaker than what the single unemployment rate suggests."

On the wage front, if the consensus expectation is met, annual salary growth will drop below 3% for the first time in over four years.

Goldman Sachs' broad wage tracker, which integrates multiple wage indicators, shows that the annualized quarter-on-quarter growth rate for Q3 is 3.0%, with a year-on-year growth of 3.3%. Deutsche Bank's proxy indicator for nominal wage growth is expected to slightly decline to 4.1%, and the bank believes this level "still supports robust consumer spending growth." It's worth noting that productivity jumped 3.6% year-on-year in Q3, far exceeding the 2.7% expectation, while unit labor costs unexpectedly fell by 0.7%.

Fed path: Rate hike expectations eroded by AI collapse

In the October meeting, the Federal Reserve held its ground, but two members cast dissenting votes.

Fed Chairman Warsh signaled that rates will rise at a "measured pace." During the sharp decline of the Nasdaq on Thursday, Cleveland Fed's Hammack still stated that monetary policy "needs to shift to a restrictive stance," leaning towards "more frequent, smaller adjustments"; Richmond Fed's Barkin expressed expectations for further rate hikes but remained uncertain about the "magnitude and pace."

Goldman Sachs economists expect the Federal Reserve to implement a second and final rate hike in December, raising the federal funds target range to 4.00%-4.25%, after which it will pause and restart rate cuts between late 2027 and early 2028. Before this week, the market's implied pricing for the December rate hike was approximately 21 basis points (around 83% probability).

Following the severe sell-off in the AI sector on Thursday, the implied pricing for the December rate hike has dropped to 17.25 basis points (around 70% probability), and the two-year Treasury yield has declined by about 12 basis points in a steepening bull market. Goldman's rates sales team noted that the two major downside risks facing the front and belly of the yield curve are: first, Trump reigniting military action against Iran after the midterm elections, reigniting inflation expectations; second, the collapse of AI trading delivering substantive growth shocks. According to Axios reports on Thursday night, Trump indicated that decisions regarding the Iran war are "coming soon."

A good data report may be the least needed thing by the market

Overall, before the release of this nonfarm data, the fundamentals of the labor market display a robust pattern rarely seen in recent years: initial claims for unemployment benefits are near a 57-year low, layoffs in October are at the lowest since 2023, job openings in JOLTS surged by 333,000, and ADP data exceeded expectations. In this situation, the risk of the employment data exceeding the consensus expectation of 65,000 actually leans to the upside, and the unemployment rate may also decrease.

The problem lies here. A strong report would provide sufficient grounds for Warsh, Hammack, and Barkin to proceed with rate hikes in December—just as the Nasdaq has just experienced its worst trading day since March 2020.

Goldman's rates sales team believes that a single data point cannot completely eliminate market pricing for rate hikes; rather, it is more likely that an acceptable employment figure will bring the December rate hike back into focus, compounding a rate issue on top of the existing AI concerns. Given the current positioning—CTA strategies have started net selling futures, and long-biased institutions are "stuck again"—this is not a recipe for a bottom rebound. Goldman's model suggests that if the market drops an additional 2.5 standard deviations from its current level, the potential sell-off in S&P 500 futures could reach $7.48 billion within the next week.

It is worth noting that the revisions to the September nonfarm data (from an initial value revised down to 133,000, and eventually down to 29,000) should also be closely monitored by the market—this revision's impact on the bond market and interest rate pricing is no less significant than the headline data itself.

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