The June employment report came in ahead of expectations with generally solid numbers, but was hardly a blow-out report. Still, bond market participants were apparently positioned for a much weaker number. Bonds tumbled on the news, spiking the yield on 10-year Treasuries by almost 20bp as everyone forgot -- or simply didn't believe -- the Fed's promise to hold to the zero lower bound into 2015. Expect dovish talk as policymakers try to rein in expectations, but I suspect the damage is done, the genie is out of the bottle. If the Fed wants to regain credibility, they will need to stop talking and start doing by making clear the taper is not going to happen this year. That however, is not going to happen. At this point, it is pretty unlikely the data will come in sufficiently weak to postpone a September cut in the pace of asset purchases.
Nonfarm payrolls gained 195k compared to expectations of 161k rise. The previous two months were revised up, tacking on another 70k jobs. The 12-month moving average is now just below 200k jobs/month:
In the context of the Yellen indicators, the overall picture is hardly inspiring:
I wouldn't read too much into the stable unemployment rate; nothing here to suggest that a taper-driving downward trend has been broken. Other indicators are generally in line with recent trends:
Wage growth is holding near 2% year over year. Nothing inflationary about that, and consistent with substantial slack in labor markets. Aggregate weekly hours continues to track its upward trend, while labor force participation and employment to population ratio both ticked up 0.1%. Underemployment indicators also still reveal substantial slack in labor markets:
Reductions in the "employed part time for economic reasons" category appears to have stalled in recent months -- more evidence of slack. The economy needs to be running hot enough that firms have neither the need nor the ability to hire part-time workers looking for a full-time job. There was a jump in the number of marginally attached, but I think it is too early to say it is anything but statistical noise.
Jim Tankersly notes that manufacturing employment fell in June, which seemingly defies expectations for a manufacturing revival in the U.S. My expectation is that productivity gains will most likely offset much of the growth in that sector. In other words, the sector could boom, but the impact on jobs might be minimal.
Does anything in this report change the expected path of monetary policy? No, it simply confirms the current expected path of tapering beginning in September. I think those looking for data to delay that tapering will likely remain disappointed. It needs to be emphasized that the Fed has already dismissed the data that could delay tapering as unimportant. Recall New York Federal Reserve President William Dudley:
...I continue to see the economy as being in a tug-of-war between fiscal drag and underlying fundamental improvement, with a great deal of uncertainty over which force will prevail in the near-term. This tug-of-war is clearly seen in the monthly employment data. Over April and May, the average monthly gain in employment in the private service-providing sector has been well maintained at 175,000. In contrast, employment in the manufacturing sector and the federal government declined a combined 20,000 per month. And the resulting uncertainty is, I believe, an important contributing factor behind the relatively sluggish pace of business investment spending.
My best guess is that growth for all of 2013, measured on a Q4/Q4 basis, will be about what it has been since the end of the recession. But I believe a strong case can be made that the pace of growth will pick up notably in 2014.
As long as the private sector job numbers continue to defy the fiscal contraction, the Fed will ignore weak GDP reports as transient in nature. The same is true for inflation:
Finally, I believe this tug-of-war analogy is useful in explaining the recent inflation dynamics. As is well known, total inflation, as measured by the personal consumption expenditures (PCE) deflator, has slowed sharply over the past year and is now running below the FOMC’s expressed goal of 2 percent. Softness in energy prices, resulting from the weakening of global growth mentioned earlier combined with increased energy production here in the U.S. has contributed to the slowing of total inflation. However, it is also the case that core inflation, that is, excluding food and energy, has slowed sharply as well. A decomposition of core inflation reveals that some of the decline is due to slowing in the rate of increase in prices of non-food and non-energy goods. This probably is due in large part to the softening of global demand for goods and the modest appreciation of the dollar that has occurred since mid-2011.
In the service sector, the rate of increase in prices of medical services and 'non-market' services -- the latter includes some financial services -- also has slowed notably recently. In contrast, the rate of increase in prices for other non-energy services has been relatively stable. Comparing this set of conditions to that in 2010, the recent slowing of inflation has been less widespread across core goods and core services, and inflation expectations so far have declined less appreciably than they did in 2010. Thus, my best guess is that core goods prices will begin to firm in the months ahead as global demand begins to strengthen and inventories get into better alignment with sales.
Moreover, it should also be emphasized that the Fed will heavily discount weak data as we approach September. This was a little-noticed paragraph from a recent speech by Federal Reserve Governor Jeremy Stein:
In addition to guidance about the ultimate completion of the program, market participants are also eager to know about the conditions that will govern interim adjustments to the pace of purchases. Here too, it makes sense for decisions to be data-dependent. However, a key point is that as we approach an FOMC meeting where an adjustment decision looms, it is appropriate to give relatively heavy weight to the accumulated stock of progress toward our labor market objective and to not be excessively sensitive to the sort of near-term momentum captured by, for example, the last payroll number that comes in just before the meeting.
This employment report will be heavily weighted into the pile of evidence supporting tapering in September. Weak data from this point on is weighted in proportion of the time until September. The closer we get, the less important is the data, and thus we need to see even bigger downside disappointments to change the path of policy. Indeed, I suspect this is part of the reason for the outsized bond market move today. The ability to take a long-position on the expectation of delayed tapering dropped dramatically this morning. Simply put, I very much suspect that the Fed has a bias against weak data.
Bottom Line: A solid but not spectacular employment report. But the Fed is only looking for solid at this point to justify winding down quantitative easing. And time is running short to delay tapering. I suspect that incoming data has more to do with future reductions in the pace of asset purchases rather than the date that those reductions will begin. I suspect there will be little data between now and September of sufficient negative magnitude to dramatically alter the near-term path of policy.