Lackluster jobs report doesn't force the Fed's hand on rates

Lackluster jobs report doesn't force the Fed's hand on rates
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Pessimism in financial markets regarding the economic outlook has been building rapidly in recent weeks, as trade negotiations with China broke off in early May and then the Trump administration decided to threaten tariffs on Mexico to achieve its goals on illegal immigration. 

Expectations of Fed easing this year have been building in recent days. Thus, the May employment report comes around at an especially critical time for the markets.

The weak jobs gain of 75,000, about 100,000 less than the consensus expectation, has therefore taken on particular import. The reading is either an early harbinger of a substantial economic slowdown or an extremely ill-timed instance of month-to-month volatility in the data. I would lean toward the latter. 

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The payroll figures have been extremely erratic all year, and, after a robust April figure (even taking into account a downward revision), a sub-par result in May could simply be another rotation on the see-saw.

To illustrate the degree of variability in the monthly jobs figures, the year-to-date average is 164,000 per month, but only one of the five reports has been inside of a range of 75,000 to 224,000. Given that pattern, it would not be especially surprising to see a reading in excess of 200,000 in June — unless the economy truly is rolling over.

If the hypothesis is that trade tensions are torpedoing the economy, then there is not much confirmation in the May payroll report.

If trade were the driver for the weak report, then one would expect the softest sectors to be manufacturing and perhaps wholesale trade. Instead, those two sectors were both in line with their year-to-date averages, up 3,000 and 7,000, respectively. 

The softening in May relative to prior trends came in domestically-focused industries like construction and various service sectors, most notably health care, which was about 20,000 below the trend over the past year.

So, either the economy is deteriorating rapidly having nothing to do with trade difficulties or May’s soft jobs number represents the natural ebb and flow in a series that has historically had tremendous volatility.

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In the aftermath of today’s report, financial markets are pricing in about a 90-percent probability of a Fed rate cut at the meeting at the end of July (with about a 25-percent chance of a rate cut at the June meeting, only a week-and-a-half away). 

Fed officials have made clear in recent public appearances that they are watching developments closely but are in no particular hurry to respond to a rapidly evolving situation.

An early pre-emptive move by the Fed this summer, unless it followed an extended string of data that looked like Friday’s soft jobs gain, could be premature, as the trade negotiations could take a positive turn and quickly bring the economy back to the pre-May status when:

  • economic growth was above trend;
  • the unemployment rate was at a 49-year low (by the way, it still is, as the May figure remained at 3.6 percent); and
  • inflation was only modestly below the Fed’s 2-percent target. 

Conversely, if the Fed holds its fire for too long while the economy is subject to heightened downside risks, it could allow downward momentum to build. 

If we get more data points like Friday's, the Fed’s hand will likely be forced, but I believe that the economy is in far better underlying condition than the Treasury market seems to think and that the economy should weather the storm until the trade negotiations turn more positive. 

As a result, I do not look for a Fed rate cut this summer, in stark contrast to the prevailing market view.

Stephen Stanley is the chief economist at Amherst Pierpont Securities LLC.