US: Another strong jobs report makes it more likely Fed will hike in H2 16 – Danske Bank

Senior Analyst, Mikael Olai Milhøj at Danske Bank, notes that we have now had two strong jobs reports in a row following the two very weak reports in April and May.

Key Quotes

“Employment rose 255,000 in July, higher than expected by analysts and higher than indicated by the ADP jobs report. The big increase was in line with early indicators such as the Markit PMI employment subindex and claims data. Most parts of the report were strong. Employment growth in May and June was revised up by 18,000 in total, average hourly earnings rose slightly more than expected (0.3% m/m versus 0.2% m/m), the participation rate rose from 62.7% to 62.8% and average weekly hours rose from 34.4 to 34.5. The weak part of the report was that the underemployment rate, which is a broad unemployment measure the Fed uses to analyse how much slack remains in the labour market, rose from 9.6% to 9.7%. The declining trend in both the headline unemployment rate and the underemployment rate have both slowed over the past year.

Although it is good news that employment growth has rebounded sharply after the two weak jobs reports in April and May, employment growth has levelled off this year compared with the past couple of years. On average, employment growth has been 190,000 per month this year compared with 230,000 in 2015 and 250,000 in 2014. This could be a sign that hiring has slowed, as we are close to full employment, meaning that employment has become more expensive and it is more difficult to find employees with the right qualifications. However, we have not seen a pickup in productivity growth, as employment growth has slowed simultaneously with weak economic growth over the past three quarters. The strong report reduces some of the concerns about the current economic situation in the US but we still need further data to confirm that both GDP growth and employment growth are still on track.

Average hourly earnings rose 0.3% m/m, which was slightly better than expected (0.2% m/m), implying that the annual growth rate was still 2.6% (but a big one). Although this is the highest level post-crisis, it is still significantly lower than pre-crisis levels, suggesting that the underlying domestically generated inflation pressure is still subdued. It is important to notice that the Fed sees the world through the Phillips curve, so the subdued wage inflation is a sign that slack remains in the labour market.

Despite the strong jobs report for July, we stick to our call that the Fed will stay on hold for the rest of the year, although it makes a hike later this year more likely. Our scepticism is due to a combination of weak GDP growth rates over the past three quarters and slower employment growth this year compared with 2014 and 2015 and because it is still too early to conclude whether the Brexit slowdown in the UK will spread to the rest of Europe and thus potentially also the US.

Also, the China ghost still lurks. As we have argued for some time, most voting FOMC members have a dovish-to-neutral stance on monetary policy and would rather postpone the second hike than hike prematurely. The Fed can afford to stay patient as PCE core inflation is still below 2%, inflation expectations (both survey based and market based) have fallen and wage inflation is still subdued.”