The US ADP employment change four-week average fell to 35.75K as of 2 May, down from a prior reading of 42.25K. The move points to a softer pace of private payroll growth over the latest four-week window.
In absolute terms, the decline amounts to 6.50K. Even so, the average remains positive, indicating continued expansion in employment by ADP’s measure.
Evidence Points to a Cooling Labor Market
We are viewing the decline in the ADP employment average as a significant early warning of a cooling labor market. The drop from 42.25K to 35.75K in the four-week average is not just a blip, but a trend suggesting that hiring momentum is fading. This points toward weaker economic activity as we head into the summer months.
This perspective is reinforced by the most recent official jobs report, where April’s Non-Farm Payrolls came in at a disappointing 85,000, well below the consensus forecast of 150,000. Additionally, the latest CPI data released in mid-May showed core inflation moderating to 3.1%, its slowest pace in over a year. This combination of a soft labor market and easing inflation strengthens the case for a more cautious Federal Reserve.
Market Implications and Positioning
Given this data, we believe the market is underpricing the probability of a Federal Reserve rate cut later this year. The CME FedWatch tool now shows a 65% probability of a rate cut by the September meeting, up from just 30% a month ago. We are therefore positioning for a downward shift in short-term interest rates by looking at SOFR and Fed Funds futures.
For equity index derivatives, the outlook suggests a period of heightened volatility. The tension between a slowing economy (bearish) and the potential for easier monetary policy (bullish) will likely lead to choppy markets. We are therefore looking to buy protection via put options on the S&P 500 or purchasing VIX call options to capitalize on expected price swings.
We also anticipate the U.S. dollar will weaken as interest rate cut expectations become more entrenched. Historically, the dollar index has fallen an average of 2-3% in the three months leading up to the first rate cut of a new easing cycle. This makes options on currency futures, particularly those for the Euro and Japanese Yen, an attractive way to position for this shift.
