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Sorry for the light blogging this week - just getting back into the swings of things during the first week of spring term. But nothing like an employment report to pull me out of hibernation.

It is no secret that the employment report has a significant impact on monetary policy. And we need to make increasingly deeper dives at the data to discern the implications for policy. Federal Reserve Chair Janet Yellen made that clear in her speech this week when she outlined a number of indicators - part-time but want full-time, wages, long-term unemployment, and labor force participation - as evidence of slack in the labor market. Such slack is sufficient, in her view, to justify maintaining accommodative policy for a considerable period (although note that accommodative does not mean zero rates).

Yellen, I think, outlined the most dovish case possible given the current information set. This suggests to me that the risk lies in the hawkish direction. Moreover, I think that Yellen and the remaining doves are losing the internal policy battle, leaving policy with a generally overall hawkish tone. Gone is the Evans rule and explicit allowance for above target inflation, gone, it seems, is a low bar for slowing the taper, gone is quantitative guidance in favor of qualitative guidance, gone is rules-based policy in favor of ad-hockery. And now departing Governor Jeremy Stein leaves behind an intellectual legacy that raises the importance of financial stability concerns when setting policy. Altogether, the stage is set for the Fed to move in a sharply more hawkish direction with just a little push from the data.

That said, that little push from the data is important. While I believe that the Fed has a hawkish bias, that bias will not be realized in the absence of data that is reasonably stronger than the Fed's forecasts. Which brings us to the next employment report. In general, the consensus view that the labor market shook off the winter doldrums with a 206k gain in nonfarm payrolls and 6.6% unemployment rate is probably pretty close to the Fed's expectations. The forecast range for payrolls, however, is skewed to the upside, with a range from 175k to 275k. The possibility of upside surprise follows from an expectation of a sharper bounce from earlier weather-related softness. This was evident in the employment component of the ISM Services report:


In addition, weekly initial claims have improved in recent weeks, lending additional credence to expectations for a better-than-expected report:


Finally, the ADP number for private employment growth came in at a solid 191k for the month (noting of course, the less than perfect signal ADP provides). My quick and dirty approach - which admittedly was not particularly effective in recent months - points at a NFP gain of 199k in March, in line with consensus expectations:


As always, usual caveats apply. Guessing the preliminary numbers of a heavily revised data series is by itself something of a questionable game, a game we all play nonetheless.

As I noted earlier, however, headline numbers won't tell the whole story. The Fed will be looking deeper into the numbers for evidence of greater slack than indicated by the unemployment rate. My opinion is that if the slack is diminishing faster than the Fed doves expect, it is most likely we will see wage growth accelerate. If wage growth remains low, then the Fed will be confident that there is little incipient inflation pressure to justify a more aggressive reduction of policy accommodation.

Bottom Line: The baseline case remains zero rates until the middle to end of 2015, followed by a gentle pace of rate hikes. That said, it is all data dependent, and the baseline case appears to be contingent on a particularly dovish forecast. It seems to me that the risk thus lies in a less than dovish reality. Signs that wages are increasing more rapidly would suggest just that. Still stagnant wage growth, however, gives the Fed more room to stick with the current policy path.

Source: Employment Report Ahead