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Payroll Trend Puts Markets and Fed Mandate at Loggerheads
Friday, Jun 03, 2016

“After all that.” And this time, it was the jobs report.

It was another day of disappointment for Federal Reserve policymakers and the financial market participants who hang on their every word. Once again, just as the economic data and financial market prices seemed to be aligning for the Fed to be able to take another step forward in its path to normalizing monetary policy, we hit an air pocket. After policy makers worked so hard to talk up market expectations for a rate hike this summer, the market just revised its estimated probability of a rate hike in July down to nearly 35% from just under 60%.

The difference is that this time, the fly in the ointment for markets and policy makers was what has been the stalwart of U.S. global economic data: the U.S. jobs machine. Unfortunately, that also means a direct impact on U.S. households and job seekers.

Or does it? The headline figure of 38,000 jobs added to nonfarm payrolls was a big disappointment: over 100,000 lower than consensus expectations and only half of, or perhaps a bit less than, the number required to absorb new entrants in the labor force (sorry, college grads). However, like most monthly economic data, nonfarm payrolls are inherently volatile and have been unusually consistent in recent years, expanding for 68 straights months, so we may have been overdue for an off month.

Thus, it may be a little early to judge the impact on Main Street and the job seekers that walk it. That said, there has been some slowing in payroll growth leading up to this report. The latest print brings the 3-month moving average down to 116,000, roughly half the 12-month average of 229,000 over the course of 2015 as a whole. For now, that is still enough to absorb new workers, but may yet put the markets and the Fed back in a tug of war.

Why? Because slower job growth – if not quite as slow as the May figure – suggests we are still close to maximum sustainable employment and the Fed needs to respond to that. Leading up to this report, there was some debate about whether the recent slowing was due to the U.S. labor market approaching “full employment” or payback from job growth that was pulled forward into unseasonably warm prior months. The breadth of the weakness in this report undermines the weather theory.

Yet responding to “full employment” with a rate hike just got harder for the Fed, both because it will probably want to wait and see that this is indeed just monthly volatility and because the markets have responded so strongly to the May report.

Indeed, while it is just one report, it was not a mixed one: there was weakness through and through, including both the establishment and household surveys. While the survey of U.S. households indicated the unemployment rate declined by an outsized amount to 4.7% from 5.0%, it did so for the wrong reasons: labor force participation continued to decline, reaching its lowest level since last December most erasing most of its recent gains. Workers who had to accept a part-time job instead of a full-time one rose by nearly half a million, to a level last seen in August 2015.

Turning to the survey of employers, the news is slightly less bad. Most major industry categories reported slowdowns in job growth and many of them reported outright job losses. For the wonks out there, this gets summarized in the job diffusion index dropping to 51.3% from 53.8%. This looks a little fluky – supporting the idea that this is report is partially attributable to inherent volatility – compared to recent reports of unemployment insurance claims data, where there have been some upticks, but nothing to suggest a serious turn for the worse.

The few industries to escape the carnage and report a pick-up in job growth included retail trade (consistent with recent strong consumer spending and also undermining the weather-related theory), education/health, and government. As expected, the information category and its telecommunications subcategory suffered under the weight of the Verizon strike, but even if you correct for that, the 3-month moving average for headline payroll growth rises to just 127,000. Unfortunately, there was no offset from temporary hiring, and the decline in the latter category was yet another cause for concern.

Wage growth held steady at 2.5% year-over-year, and the average workweek was unchanged at 34.4 hours. There’s some comfort for Main Street in the idea that the labor market didn’t completely fall out of bed, but policy makers may take a less sanguine view. The Fed’s Beige Book indicated widespread anecdotal reports of tight labor markets and mounting wage pressures. Inflation looks to be firming and with energy prices rising, there is good reason to expect that inflation expectations will rebound as well.

If the Fed still thinks it is getting close to its mandate for maximizing employment, then it will feel pressure to focus on its mandate for price stability – by raising rates. This is especially true when consumer spending is rising at a healthy clip and GDP growth is expected to rebound in the second quarter. The problem is, the market just reduced its expectations for rate hikes, and the Fed doesn’t want to upset the markets when U.S. growth is modest and global growth is still looking weak.

It still looks like a June rate hike is off the table – there’s not enough time left for new data to change the outlook – but Fed speeches and official statements may yet continue to talk up a summer hike. Fed Chair Janet Yell speaks on Monday, but it remains to be seen how markets will respond after getting wrong-footed earlier this year. So stay tuned, and turn up the volume.

about the author

As chief economist at iCIMS, an industry-leading provider of talent acquisition software, Josh Wright leads a team of data scientists in analyzing emerging trends in the U.S. labor market