- Given recent string of data, a disappointing US report will be shrugged off.
- Next week's JOLTS data may be more important for Fed officials.
- It is divergence between the US and Europe that is the key driver of the capital market presently.
The ADP report has been a fairly good guide in recent months of the government's initial estimate of private sector payroll changes. It steals much of the thunder. The decline in weekly initial jobless claims and both ISM surveys gives reason to expect a continuation of the recent trend. Over the past five months, the US has created a net 1.24 mln jobs. Less than 70k were government positions.
There is asymmetrical risk. A disappointing report will likely be quickly shrugged off, while a significantly stronger report will heighten speculation that gap between the end of QE and the first rate hike will be smaller. The recent string of US economic data, including the non-manufacturing (highest since August 2005), yesterday's auto sales (highest since early 2006) and the upbeat Beige Book indicate a fairly good Q3 GDP. The composition of growth may shift a bit away from consumption and toward business investment and inventories and government spending - it is an election year after all.
We have characterized Fed policy as on autopilot. The data will not change this. The Fed will end QE. We have been consistently looking for a Fed hike in the middle of next year. This still seems reasonable. The main issue before the FOMC will continue to be preparing the market for the next step. This is not only a communication challenge, but also substantively, as we saw with the adjustment of the term deposit facility on Thursday.
Almost regardless of tomorrow's data, the FOMC's statement will likely be tweaked to prepare investors. It will likely stress that the timing and magnitude of policy will be increasingly data dependent. Yellen has guided investors away from simply looking at the unemployment rate, which could tick down to 6.1% or even 6.0%. Hourly earnings may tick up, but the year-over-year rate is steady around 2%.
Some economists are arguing that as nominal wages proved sticky on the downside during the recession, their stickiness during the expansion is not necessarily a robust sign of slack in the labor market. That said, few want to press the point to its logical conclusion; namely that wages are not simply a function of supply and demand as are other commodities. Wages also reflect a power relationship.
It is clear that as recently as the July FOMC meeting and Yellen's late August Jackson Hole talk, a majority still recognized "significant under-utilization" of labor. The July JOLTS report, to be released next week (September 9), may contain more important information about the labor market than the non-farm payrolls report itself for Fed officials.
A Fed staff paper made available this week found that most of, but not all of the decline in the participation rate is likely structural in nature and policy makers should not expect to recover much. However, there is a cyclical component. It appears to have bottomed at 62.8%, which was seen in Q4 13 and again in Q2 14.
The number of people taking part-time work because they can't find full-time employment remains elevated, though it has been gradually declining. The broader measure of unemployment that also picks this up is U-6 has fallen from 17.2% at its peak in April 2010 to 12.2% in July. The more commonly cited U-3 measure has fallen from 10% in October '09 to 6.2% in July.
Bottom line: The relative strength of the US economy is well appreciated, and the jobs report will not change perceptions. QE in the euro area and continued asset purchases by the BOJ offer stark contrast with the US. Rate differentials are moving in US favor, mostly because of the collapse of euro area bond yields. US Treasuries and gilts are now among the high yielders. Consider that sovereign yields out to three years in German, France and Switzerland are negative. Sterling's ability to outperform the other European currencies is hampered by the upcoming Scottish referendum. Although the most likely scenario is that independence is reject, it does seem a closer call and the potential impact of a "yes" vote is significant.