The Fed and Payrolls: FOMC's battle to change perceptions - ING

James Smith, Economist at ING, suggests that after two months of bumper non-farm payrolls (NFP) figures, we look for a sub-consensus drop back to 150,000.

Key Quotes

“This may come as a disappointment and prompt markets to push out rate hike expectations, but does a lower NFP number matter for the FOMC anymore? Recent FOMC speakers suggest not.

The FOMC no longer needs to see 180,000+ NFP

One thing that most FOMC members appear to be agreed upon is that the economy is at, or at least close to, full employment. As the pool of available labour evaporates, the rate of decline in unemployment has slowed. Job creation need only keep pace with increases in the overall size of the labour force. An increasing number of Fed speakers have said that they would be comfortable with sub-150,000 NFP, most notably Fischer (75,000-150,000).

Markets could be left disappointed by Friday’s NFP, even if the FOMC isn’t

Two strong months of job creation more than compensate for the rapid decline in April and May. A third month would be too good to be true, if the theory above is correct. Our FX team has for some time noted that markets have become more sensitive to wage surprises relative to NFP. But it seems markets may not have fully adjusted to the FOMC’s new NFP thinking, and an excessively low figure this week would prompt some Fed re-pricing (at least for September). This disparity between market and Fed perceptions could be a vulnerability when the FOMC comes to hike rates again (note: May’s poor NFP took a potentially viable June hike off the table, albeit ignoring Brexit) – expect more Fedspeak on this subject.

Wages are now key for the FOMC – and may be finally turning a corner

Despite a remarkable labour market recovery since the crisis, wage growth has remained low. But according to Atlanta Fed measures, those workers moving jobs are starting to see pretty sizeable wage increases (4.2% YoY). Historically, this has a tight relationship with overall pay (with a lag) – is this the first sign of a more pronounced upturn in wages? Going by recent comments, Chair Yellen and other voting members are becoming more optimistic on wages.

The FOMC’s neutral rate puzzle: Slower normalisation, but how slow?

Alongside NFP-related comments, the other major topic underlying recent FOMC speeches has been the low neutral rate. This is the level of interest rates which is neither expansionary nor contractionary for growth. The idea of low long-term rates is not new and markets have become well-conditioned to it. But the issue for the FOMC is judging exactly where the neutral rate is, as the “rate gap” (difference between the real Fed Funds rate and the neutral rate) determines how loose or tight monetary policy is. Neutral rate estimates by the San Francisco Fed are close to zero, implying that current policy is close to being “growth neutral”. If so, the FOMC will continue to be in no rush to hike.

FOMC to wait for political uncertainties to pass – we expect a 1Q17 hike

If the FOMC is indeed in no rush, then it makes sense to wait for the US election to pass. There are also potential stumbling blocks in the form of the Italian Referendum and increased Brexit-related headlines. If these events pass without tightening financial conditions or hitting economic activity, we think the FOMC will hike rates in either December or, more likely, early next year.”