Solid Jobs Report Keeps Fed In Play

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Includes: DIA, IWN, QQQ, SPY
by: Tim Duy

Summary

Just when you think it's safe to jump in the water, reality strikes.

Non-farm payrolls grew by 151k, below consensus, but within a reasonable range of estimates.

Notably, wage growth has accelerated over the past year, suggesting that the Fed's estimate of NAIRU is within the range of reality.

Just when you think it's safe to jump in the water, reality strikes. While I still think that the Fed passes in March, the solid jobs report is just what it takes to keep the Fed in the game. Back it up with another such report in March (February number released on March 4) and a stronger inflation signal in one of the upcoming price reports and you set the stage for a divisive battle at the next FOMC meeting.

Non-farm payrolls grew by 151k, below consensus, but within a reasonable range of estimates. The 12-month moving average reveals a very modest slowing of job growth over the year:

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The jobs numbers in the context of data Federal Reserve Chair Janet Yellen pervasively identified is what to watch.

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Notably, wage growth has accelerated over the past year, suggesting that the Fed's estimate of NAIRU is within the range of reality.

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Prior to the 2001 recession, wage growth typically accelerated as unemployment approached 6%. Now it looks like 5% is the magic number.

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I suspect the employment cost index will soon follow the wage numbers higher.

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There are no signals of recession in this data. For those who will complain that it is lagging data, I suggest watching the temporary employment component.

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Temporary hiring should flatten out as the cycle matures, and you can arguably see the beginning of that process. If you squint, that is. Even so, the process evolved over a two-year period before the last recession struck. Even if the seeds of recession were sown this January, we wouldn't expect recession until 2017 at the earliest. Still not by base case; using history as a guide, I have a recession pencilled in for 2018 (Short story: economy is in later stages of a business cycle, Fed resumes tightening later this year and pushes it too far by middle of 2017. In a perfect world the Fed could moderate the pace of activity to hold unemployment near NAIRU for an extended period of time. That, however, has proven to be a challenge for the Fed in the past).

Bottom Line: This jobs report complicates the Fed's decision-making process. It is stuck with instability in the financial markets as the economy reaches full employment. It is concerned that in the absence of temporary factors, inflation will quickly jump higher if the economy continues on this trajectory. While it would like unemployment to settle somewhat below NAIRU to eliminate lingering underemployment, it doesn't want it to settle far below NAIRU. It doesn't believe it can easily tap the brakes to lift unemployment higher. Recession is almost guaranteed to follow. Hence it would like to be able to raise rates gradually to feel its way around the darkness in which the true value of NAIRU lies. The Fed fears that if it delays additional tightening, it will pass the point of no return in which it is forced to abandon its doctrine of gradualism. The Fed's policy challenge just became a little bit harder today.