The Job Market and the Fed

The October Employment Report was stronger than expected, but should be seen in its proper context. That is, while October’s payroll gain far exceeded forecasts, it followed softer figures in August and September. The three-month average was moderate. Financial market participants believe that the report makes a December 16 rate hike a lot more likely. However, the Fed had already been signaling that such a move was likely.

Nonfarm payrolls rose by 271,000 in the initial estimate for October. Seasonal adjustment is often a bit tricky in the late summer and early autumn as the school year gets under way. We added 1.152 million jobs prior to the seasonal adjustment (vs. 1.082 million in October 2014 and 938,000 in October 2013), with about two-thirds of that gain in education. The three-month average for the adjusted payroll gain was +187,000 (a 2.2 million annual rate, vs. 3.0 million jobs added in 2014) – still well beyond the +120,000 monthly pace that would be consistent with population growth.

The unemployment rate was essentially unchanged (5.036%, vs. September’s 5.051%), the lowest since April 2008. The employment/population ratio is trending about flat. Some Fed officials dismiss the e/p as distorted, largely reflecting a demographic change in labor force participation. Yet, it’s also likely that the job market is a lot more flexible than the household survey data would suggest. That is, there are many individuals who could be lured back into the job market if there were a good enough job available. Two gauges that Fed Chair Yellen highlighted, long-term unemployment and the percentage of people involuntarily working part-time, continue to signal improvement, but they still have some way to go.

The Fed is not going to react to any one piece of economic data, including the October Employment Report. However, it should have been clear that officials were already leaning heavily toward a December move. Fed policymakers expect to see a lot less slack in the labor market a year from now. They anticipate that inflation will move back toward the 2% goal as the transitory impacts of low energy prices and lower import prices fade. Recall that the Fed came very close to raising rates in September, but delayed, citing possible restraints on the U.S. from global economic and financial developments. The downside risks from the rest of the world now appear to be a lot less worrisome than they did two months ago. Exports are down, but not terribly so, with most of the year-over-year decline being a reflection of lower prices for food and industrial commodities. A Fed rate hike would put some upward pressure on the dollar in the short term, but the exchange rate of the dollar is the Treasury’s call and the Fed has to do what it has to do for the domestic economy. Still, the impact of a stronger dollar (restraint on exports, lower import prices) suggests that the Fed will likely be very gradual in raising rates over time.

Labor productivity figures bounce around a lot from quarter to quarter, but the trend over the last few years has been disturbingly low (about a 0.5% annual rate). It’s unclear exactly why productivity has slowed, but it does add to concerns about secular stagnation. All else equal, a slower trend in productivity growth implies that the Fed should be quicker in raising rates (as the job market will tighten more rapidly at any given growth rate for GDP), but at the end of the cycle, the central bank should end up raising rates a lot less. That fits in with the idea of a December hike and a gradual pace thereafter.

Stock market participants need not fear a Fed tightening cycle. The initial move will reflect an optimistic economic outlook. Monetary policy will still be very accommodative even after the first couple of rate hikes. Still, we may see some volatility as the markets try to figure it all out. Fed officials can help by simplifying the message.

© Raymond James

© Raymond James

Read more commentaries by Raymond James