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11 09 2015 | by Victor Xing | Economics

October Payrolls (Nov 6th) and FED policy implications

The above-consensus October Nonfarm Payrolls would boost Federal Reserve officials’ confidence that stronger labor market will help push inflation back to FED’s 2% objective over the medium term, especially in-light of higher Core inflation prints and hawkish FED communications (FOMC Statement and speeches), further raising the likelihood of December policy liftoff.

October Payrolls

The highly anticipated October non-farm payrolls (official BLS Employment Situation Summary) came in at 271,000 vs. 190,000 consensus with prior two months’ data revised up 12,000 (please see Appendix 1).  Monthly job gains above 250,000 are in the “strong to quite strong, or blockbuster” territory, and the latest data point is an encouraging reversal following recent months’ softer (but still decent) data prints.

As expected, unemployment rate (U-3) declined to 5.0% in October.  Recall Federal Reserve’s September FOMC Summary of Economic Projections, the FOMC’s long-run NAIRU projection was between 4.9% to 5.2%, therefore 5.0% unemployment under normal circumstances would suggest the FED’s maximum employment mandate is being met or close to being met.

However, the U.S. economy recovery since the 2008 financial crisis was anything but normal, and labor market slack can be better measured by broader labor market indicators, namely the U-6 unemployment rate, part-time workers for economic reasons (involuntary part-time workers), labor force participation rate(especially the prime age participation rate), long term unemployed as a percentage of unemployed, and average hourly earning (measure of wage inflation and indicator of tighter jobs market).  Please see the next section – broader labor market indicators.

Broader labor market indicators

U-3 and U-6 unemployment rates (blue and red, respectively) and part-time workers for economic reasons as a percentage of labor force (gold) declined in the month of October.  U-3 declined to 5.0% from 5.1%, U-6 declined to 9.8% from 10.0%, and involuntary part-time workers (as a percentage of labor force) declined to 3.67% from 3.85%

Payrolls unemployment rate

Long-term unemployed as a percentage of unemployed edged up to 26.8% vs. 26.6%

Payrolls long-term unemployed

Headline labor force participation rate (blue) at 62.4%, unchanged vs. prior,prime age participation rate (red) rose to 80.7% vs. 80.6% prior

Payrolls participation rate

Average hourly earnings (AHE) at 2.49% YoY vs. 2.20% prior.  Blue line refers to ECI, the Federal Reserve’s preferred measure of labor costs (Federal Reserve Bank of Kansas City – a Closer Look at the Employment Cost Index), available on a quarterly basis

Payrolls ECI vs. AHE

 

FED policy implications

The October FOMC Statement (released on Oct 28th) was broadly perceived as more hawkish than expected

The FOMC acknowledged slower pace of job gains (referring to prior months’ payrolls data), but concerns over foreign economic risk factors were removed from the statement (likely in response to China’s Central Bank Moves to Spur Economic Growth)

Payrolls in respect to FOMC Statement

Moreover, the FOMC for the first time explicitly referred to its December meeting in the Statement – a move which likely required considerable deliberation within the Committee on the risk of sending the wrong signal.  Since the FOMC accepted the risk of possible miscommunication, it implies the probability of Dec liftoff is considerable higher (or to put it in another way – “all meetings are live, but Dec meeting is more live than others“)

Payrolls in respect to FOMC Statement

Recent communications (as of Nov 8th) have been hawkish:

San Francisco Fed President Williams commented today that it makes sense to gradually remove the policy accommodation that helped the economic recovery, although he stuck to his policy of declining to comment on the precise timing of rate hike, citing “a lot of data” between now and December.

The 2nd most dovish FED official, Chicago Fed President Evans, commented on Nov 6th that the Oct NFP was “very good” and he will go into the December meeting with an “open mind.”  This is rather optimistic for President Evans, who has called for deferring liftoff into 2016

On Nov 5th, the centrist Atlanta Fed President Lockhart stressed that “liftoff” at the Dec meeting “is a possibility, not a certainty,” but he also expressed optimism that “I think the case for [December] liftoff will continue to firm up.”

On Nov 4th, New York Fed President Dudley echoed Chair Yellen’s comment that the December FOMC is a “live possibility” for rates liftoff.

The only cautionary note was from Governor Brainard on Nov 6th, in regards to U.S. economy’s vulnerability to further weakening of foreign growth.

The feedback loop between market expectations of divergence between the United States and our major trade partners and financial tightening in the United States means that material restraint to U.S. conditions is already in place. Looking ahead, a further weakening of foreign growth could pose downside risks to the U.S. outlook. Under normal circumstances, policy in the United States could adjust to signs that spillovers from developments abroad were affecting activity in the United States. But with policy rates in the United States at the lower bound, the ability to offset spillovers from adverse developments in foreign economies with conventional policy is constrained, suggesting greater caution than normal.

On the inflation front, Core CPI and PCE are trending higher, and Owner Equivalent Rent (OER, or rental price inflation) reached 3.09% YoY in September

Payrolls - putting into perspective against inflation

Therefore, the strong October payrolls is yet another catalyst pushing policymakers toward December rate hike, but there remains cautious voices within the FOMC that may need further convincing (more to come: September JOLTS and October CPI).

Marker reactions

The 5s30s curve spread went from 146 bps on Oct 26th to 136 bps on Nov 6th (a 10 bps flattening).

Post Payrolls market reaction

 

Post payrolls market performance

Some investors had expected a “power flattening” that mirrored year-end 2014, but record corporate debt issuance has weighed on long-end of the Treasury curve and tapered the momentum of bear flattening.

Post payrolls - high corporate bond issuance

Appendix 1: data release vs. Bloomberg consensus (aggregated economist projections):

Payrolls data release
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