More questions than answers for the Fed in today's payrolls report

A payrolls report that probably provides more questions for the Federal Reserve than it does answers. Today’s headline payrolls number for June printed at 209k, softer than the expected 230k, and with the April and May numbers collectively revised downwards by 110k, suggests that the US labour market has been running softer over the past couple of months or so than the market and, most importantly the Fed, had been led to believe. Casting aside yesterday’s strong ADP employment survey (which had private payrolls growing by 497k in June, whereas today’s report showed private payrolls coming in below expectations at 146k, with last month’s number also revised down by 24k), today’s report suggests a labour market that is finally showing signs of moderating and losing some steam, although of concern to the Fed will be the fact that wages growth is yet to show similar signs of moderation.

Average hourly earnings on a yearly basis rose from 4.2% to 4.4%, while the number of hours worked also increased, from 34.3 to 34.4. While these increases in themselves are not huge, as far as the Fed will be concerned they are moving in the wrong direction, putting more money into workers’ pay cheques and providing upwards pressure on aggregate demand. The increase in hours worked also suggests US corporates are not anticipating a material slowdown in activity and trying to save money by cutting the length of the working week before resorting to the harsher policy of actually firing workers. With wages growth one of the few contributors to inflation that the Fed can look to directly influence, these numbers today are probably enough to secure a further rate rise at this month’s FOMC meeting.

But where we go after the July meeting is now looking less certain. The upwards pressure on wages growth should begin easing as the post-pandemic mismatch between labour supply and demand continues to move into better balance (as evidenced by the participation rate for those in the 24-54 age group rising to a 21-year high); while the most recent NFIB survey – the trade body for US companies that employ some 50% of the US workforce - pointed to much slower wages growth over H2. Add to these things the fact that the impact of the Fed’s tightening to date has yet to be fully felt and that consumer demand is looking more sluggish, the prospect for a continued slowdown in the labour market – and by implication wages growth - looks to be growing. This argument is given more weight by the fact that much of the recent strength seen in the payrolls numbers is the result of overly strong seasonal adjustments, a source of upwards pressure that is now being taken back as these seasonal factors are revised lower again.

So, on balance, if the Fed was willing to acknowledge that it takes time for monetary policy to materially impact on the real economy, and was willing to take fully on board the somewhat downbeat survey data we are now seeing as well as extrapolating the trends being seen in a raft of economic data (not just employment statistics, but also pricing and output data too), it would likely declare a pause in the hiking cycle. But as noted above, unless we see a remarkably weak CPI number next week, there is probably enough in today’s employment report to allow the ‘hawks’ on the FOMC to successfully argue for another 25bps increase later this month. But beyond this, further rate rises will require further strong data to justify them, which we do not see materialising. Accordingly, the expectation that July will deliver the final rate hike in this cycle remains our base case scenario.