US employment report once again surprises on the topside

Today’s US employment report from the Bureau of Labour Statistics (BLS), showing an increase in the headline non-farm payrolls number of 272k (expected 180k), has definitively pushed back the anticipated timing of a first US interest rate cut. From the chances of a cut being seen in July rated at around 20% pre-release, such a move now is dead in the water, market pricing showing a first rate not now expected to come until the November or December Fed meetings.

In what is being described as "unhelpful" for the Fed as it looks to ease monetary conditions, the report has very much undermined the picture of weakening economic activity that has been presented recently by a number of other economic releases, such as the ISM manufacturing survey and softer consumption numbers, which had shown economic activity to be slowing and paving the way for a first interest rate cut to be delivered: if those reports had been keeping open the possibility of a July cut, today’s numbers have blown such a move out of the water. And further bad news, from a rate cut perspective, was delivered too by the wages numbers, which showed average hourly earnings rising by 0.4% on the month in May, or 4.1% over the year.

But despite the strength of today’s report, our base case scenario remains that the Fed will still deliver an interest rate cut this year. Firstly, despite the more intuitive private payrolls number shown rising 229k, comfortably beating the expected reading of 167k, there is a good chance that this figure will be revised lower going forward, not least because the response rate to today’s first estimate reading was reported as being just 64%, some way off the 71% average figure normally seen for the May employment report. Small businesses, the bulk of the survey respondents, are likely feeling the pressures of current high US interest rates the most and answering late to the survey questionnaire. As these late questionnaires come in, so the private payrolls figure is typically revised lower, and therefore a slowdown in private sector payrolls growth looks to be a likely proposition going forward, matching the picture being painted by reports such as the emerging upwards trend now being seen in the initial jobless claims numbers, the fall in reported jobs openings (from the JOLTS survey) and survey evidence showing falling job hiring intentions and rising concerns that job security is falling.

Second, the rebound in the monthly earnings growth number might be nothing more than a timing issue. Workers paid on a bi-monthly basis are typically paid on the 15th of the month. Employers should report pay earned for any work done each month in the report survey week, regardless of when an employee is paid. But some employers only report the wages they actually pay in the survey week. In April, the 15th fell on the Monday after the survey week, but in May it fell on the Wednesday of the survey week. So an element of May’s earnings strength may simply be an unwinding of the artificial weakness reported in April. But beyond this, other survey evidence suggests downwards pressure on wages growth is growing, while the number itself is not mix-adjusted and often revised significantly lower. The fact that the Fed itself chooses to place more value on the Employment Cost Index shows how the average earnings figures should be read with a large pinch of salt.

Finally, there are two more things that should be borne in mind. Firstly, while the BLS report came in stronger than expected today, figures from the private sector Household Survey – the unemployment rate and the labour force participation rate – were worse than expected, and are now showing employment to have risen by just 0.2% over the past year, compared to the 1.8% being reported by the BLS. And second, the BLS itself suggested this week that payrolls might have grown by about 60k positions less per month on average last year than initially reported, when taking account of the latest figures provided by the Quarterly Census of Employment and Wages, figures that are used in the annual revisions made to the monthly payroll data.

Overall, today’s report means the Fed will be leaving interest rates unchanged for a few more months yet, with the possibility of a July cut certainly ruled out. But the body of evidence pointing to the labour market not being as strong as the BLS is reporting is growing, and evidence of this weakness should start to become clearer as we go through the summer. Accordingly, the possibility of a first rate cut being delivered in September very much remains on the cards, and especially so if inflation data continues to show signs of softening.