US Payrolls Preview: In search of the trend - ING

Research Team at ING, suggests that the volatility in the labour market data has made the underlying trend in job creation hard to gauge.

Key Quotes

“A return to steady NFP growth should help embed the view that the latest blip was temporary. The FOMC is now focussed on politics both at home and abroad, making a 2016 hike unlikely, though solid economic data should warrant a 1Q17 move. Signs of positive wage growth may be the only saviour for a soft USD.

Just a blip? After recent volatile jobs numbers, we look for a return closer to trend. Last month’s bumper 265k non-farm payrolls (NFP) figure underscored Chair Yellen’s (and our own) view that the dip in employment growth during April/May was just a blip. The reason for this weakness is hard to isolate, although may be at least partially explained by weak investment in the first quarter (which persisted into the second quarter according to GDP data). Volatile data makes the underlying NFP trend tricky to gauge, but we think a return to 160-190k would be trend-consistent. That said, a 120k-plus figure is sufficient, given that job creation is slowing as the final labour market slack erodes.

Unemployment rate could fall back to 4.8% – but watch the underlying drivers. The household survey measure of employment has gone “full circle” recently, with May’s “bad fall” in the unemployment rate (almost half a million unemployed individuals left the workforce, with very few transitioning into employment) offset by the reverse effect in June. If unemployment stabilised, the total rate may have fallen to 4.8% in July.

Wage growth gradually showing signs of life – FOMC getting more optimistic. Base effects mean that our 0.3% MoM wage growth forecast will keep the YoY comparison unchanged at 2.6%. Whilst income growth has been slow to respond to labour market strength, alternative wage indicators are gradually picking up (the Atlanta Fed’s measure is at 3.6% YoY and Chair Yellen’s favoured ECI is back up at 2.5%).

Rate hike timing now hinges on “global economic and financial developments”. Barring a rapid deterioration in the labour market, the FOMC should be relatively comfortable with domestic economic conditions. Weaker business investment in 2Q GDP was outweighed by buoyant consumer spending. Assuming inflation continues to move gradually in the right direction, the next rate hike critically depends on the level of uncertainty surrounding the US election and the degree of overspill from political events in Europe. This makes a September FOMC hike unlikely, but if neither is perceived to pose a material risk to the US economic outlook, an early 2017 Fed move looks probable.

Market implications: Forget about payrolls, wages to give greater directional steer

• Another ‘goldilocks’ jobs report would see the status quo continue. Last month’s combination of a strong payrolls release and softer wage growth was received well by risk assets; the former crushed any fears of a US economic slowdown, while the latter meant that Fed rate hike expectations remained fairly tame. If anything were to foil the current benign financial market conditions, it would be a positive wage growth surprise and in this scenario we would expect broad-based USD outperformance.

• Short-term rates remain highly interconnected. The degree of co-movement across short-dated G10 yields and swap rates has risen back to levels seen in mid-2014. The theme of monetary divergence is gradually becoming a distant memory for markets (with aggressive ECB and BoJ monetary policies having altered the dynamics). For this to change, and short-term US rates to go their own way, we’ll need to see stronger US inflation dynamics. Outside risks of a positive wage surprise means that we prefer to be positioned long USD vs. high-beta FX (eg, GBP & NZD) – with both the BoE and RBNZ expected to loosen monetary policy over the next week.”