US reaction: Jobs report adds support for a 75bps hike

Key points:

• Payrolls rose by 372k, exceeding the 265k expected (although previous months were revised lower by a net 74k)
• The household survey recorded a 315k fall in employment, with a fall of on average 116k over the quarter
• Unemployment was unchanged at 3.6%, but this also reflected a 0.2% drop in labour supply and a fall in the participation rate.
• Earnings rose by 0.3% in June, following an upward revised 0.4% in May (from 0.3%).
• The still robust pace of payroll growth adds an argument for a further 0.75% Fed rate hike in July.
• On balance, we expect 0.50%, but next week’s retail sales and CPI inflation reports will be pivotal.
• Financial markets took today’s release as confirmation of a 0.75% hike in July, with yields and the dollar rising.  

Today’s employment report was somewhat mixed. Payrolls in June exceeded expectations rising by 372k, but the alternative household measure recorded a drop of 315k, averaging a decline over the quarter as a whole. Unemployment also stayed at 3.6%, but thanks only to a drop of 0.2% in labour supply, some vindication of recent Fed views that an increase in labour supply was not likely to ease inflation pressure soon. Wages rose by 0.3% in June – in line with the average pace of the last five months, but May’s increase was revised up to 0.4% and the annualized five month pace of 3.9% would be around the upper limit of the Fed’s wage tolerance. The mixed nature adds to a difficult decision in July by the Fed, considering the need to tighten and address inflation and control expectations, versus a number of signs that the economy is slowing more quickly than expected. On balance, we continue to see a 0.50% rise, but will watch next week’s CPI inflation and retail sales reports for further guidance.

June’s payrolls number rose by 372k, far in excess of the consensus 265k expected – although a milder miss considering the net 74k downward revision to the previous two month’s report. Payrolls still stand some 0.5m below the level before the pandemic. However, the 375k average monthly increase in payrolls across Q2 – though slower than the 540k in Q1 – still far exceeds the pace of job growth to be expected from the 2.0% annualized final domestic sales growth recorded in Q1, let alone the 1.6% contraction in the economy overall. From a payrolls perspective, employment gains in June were broadly based with solid increase in construction and manufacturing, while private services jobs increases – the fastest since February – were not particularly driven by rising leisure and hospitality, but rather if anything by education and health workers.

The solid pace of employment growth was not, however, matched in the more volatile household survey. This recorded a drop in employment of 315k in June. Indeed, in the past three months household employment has fallen twice and averaged -116k in Q2 down from 827k in Q1. Divergence in the two series are not normally long-lived, but there is no clear evidence as to which usually proves the more reliable indicator. The drop in this measure of employment left unemployment unchanged at 3.6% as expected. This was because labour supply also fell back in June by 0.2% on the month, resulting in a drop in participation. Recent Fed minutes cast some doubt on how much a recovery in labour supply could be counted upon to ease inflationary pressure and this would seem some vindication of this view.

Wages are the barometer of the balance between supply and demand dynamics and these rose by an annual 5.1% in June, after an upwards revised 5.3% in May. Indeed May’s upward revision reflected a faster monthly pace of expansion, now seen up 0.4% from 0.3%, but June’s rise softened back to 0.3%. Indeed, pay growth has averaged a monthly 0.3% over the last five months, an annualized pace of just below 4%. This is probably to the upper-side of the Fed’s range of tolerance for wages over the medium-term.

Today’s payrolls print makes the first real case that the Fed might need to continue to tighten policy by 0.75% at its next meeting. Recent weeks have pointed to a material softening in spending and housing activity and suggestions that the momentum has gone from the US expansion, including the Atlanta Fed’s GDP now tracker, which currently points to a near 2% annualized decline in Q2. However, if payrolls suggest that this slowdown is not yet passing through to the labour market and further if the labour market is suggesting more signs of supply-side impediment rather than recovering, the Fed may still need to tighten aggressively to avoid an unanchoring in inflation expectations. That said, it is likely that some may join Esther George, who last time voted for a smaller 0.50% hike, on the basis that the household employment numbers, like jobless claims, challenger job cuts and employment components of the ISM, point to a much softer understanding of the labour market.

After today’s release, we consider July’s rate meeting a tight call. For now, we continue with our expectation that the Fed will tighten by just 0.50% to avoid tightening financial conditions too much and pushing the economy into recession. However, we await a crucial week for data next week, which will bring both June’s latest inflation and retail sales releases. Financial markets were clearer in their response, short-term futures saw expectations for the Fed Funds Rate rise by 9bps to 3.45% by year-end. This was reflected in longer-term interest rates, 2-year US yields also rising 9bps to 3.09% and 10-year yields up 7bps to 3.05%. The dollar also rose by 0.25% after the release.