US NFP Preview: Temporary blip or turning point? - ING

James Smith, Economist at ING, suggests that after last month’s seriously disappointing labour report, this week’s data will give us greater clarity on whether the recent slowdown in job creation was a temporary blip or a sign of a more meaningful turning point.

Key Quotes

“We tend to favour the former and see some risk of an upside surprise to non-farm payrolls (NFP). However, the fallout of Brexit via financial conditions remains the FOMC’s major focus.

Non-farm Payrolls (NFP): Slowdown overdone or the beginning of a new trend? Although distorted by strike activity, last month’s 38k NFP cast serious doubt over the state of the labour market. The underlying explanation is unclear, but there are essentially two schools of thought. The more optimistic explanation is that job creation is slowing as the economy reaches a point close to full employment. Alternatively (and perhaps more likely), the 1Q weakness in business investment could be starting to filter through to the lagging labour market. If this is the case, the bigger question is then how persistent this weakness will prove to be. Incidentally, other labour market indicators (eg, quits and job opening rates, NFIB ‘jobs hard to fill’) remain consistent with a very tight labour market.

At least for now, it looks more likely that this will turn out to be a temporary blip, rather than a more sinister turning point – a view that Chair Yellen also subscribed too in her recent semi-annual testimony. We therefore believe that the recent downtrend in NFP overstates the weakness of the labour market and think that the risks in June’s Labour Report are skewed to the upside. We look for something around 160-170k, which when combined with the reversal of last month’s strike blip, puts June’s NFP at about 200k.

Unemployment rate may increase – but the underlying drivers are the key. Last month, the unemployment rate fell from 5.0% to 4.7%, a post-crisis low. On the face of it, this sounds positive, but it reflected the fact that almost half a million unemployed individuals left the workforce, with very few transitioning into employment. This could be considered as a ‘bad’ fall in the unemployment rate. We may see this effect correct somewhat, but ultimately it is the forces at work underneath that need watching.

The FOMC is becoming more upbeat on wages – expect a pick up to 2.7% YoY. At 2.5% YoY, average hourly earnings is still lower than the FOMC would like. However, in her recent testimony, Chair Yellen said that “…there are some tentative signs that wage growth may finally be picking up”. Base effects will artificially push up this month’s figure, but any upside surprise could provide some initial evidence that tight labour market conditions are finally beginning to translate into materially higher wages.

Despite Brexit, market rate hike pricing (first hike in 2018) seems too pessimistic. Before the vote, we noted that the direct near-term economic overspill from Brexit would be limited, but the indirect risk of tighter financial conditions could be more significant. This seems to be the sentiment of firms; a recent ISM survey suggested that 50% of firms are unconcerned about the effect of Brexit on trade links, but only 10% weren’t worried about financial market uncertainty. For now, our financial conditions index is actually indicating marginally looser conditions than pre-vote. This may of course change, and the current market uncertainty, combined with any elevated investor concerns surrounding the forthcoming US election will probably be enough to keep the FOMC on hold until early 2017 (assuming that the data remains in check). Crucially though, this is much earlier than is currently being priced by markets, that are not expecting any hikes until 2018.”