Will rotten payroll growth cause the Fed to delay? It shouldn’t.

June 3, 2016 03:02 PM

It seems like every time there is a consensus on Federal Reserve Board policy something happens to muck it up. A series of positive economic indicators over the past few weeks had created a pretty solid consensus that the Fed would raise the Fed Funds rate a quarter percent at the June FOMC meeting.

Then came today’s Employment Situation Report, which showed measly growth, 38,000, in nonfarm payrolls. This was 120,000 less than anticipated. In addition to that the April payrolls number was revised to show 37,000 fewer jobs created than initially reported. This caused massive speculation in business media that a June rate hike was off the table.

To further complicate matters, the actual headline unemployment rate dropped to 4.7%, its lowest level since 2007. So you have the anomaly of having the lowest level of monthly job growth since 2010 coupled with the lowest unemployment rate since November 2007.

There is often a disconnect between the two series where a large increase in jobs is not reflected in the headline unemployment number and vice versa. The reason is that they are two separate surveys and as jobs become more plentiful, people who had previously given up looking—and have been pushed into the discouraged worker category, thus no longer measured—are now back in the market. This is measured in the participation rate, down in May to 62.6% from 62.8%. However, the anomaly in the May number is pretty extreme. For the unemployment rate to drop from 5% to 4.7% is huge.

Just yesterday Reuters reported that Dallas Federal Reserve Bank President Robert Kaplan reiterated his view that the Fed should tighten soon because the economy is getting "pretty darn close" to full employment and inflation is starting to rise.

If the economy is close to full employment that would be considered potentially inflationary and reason to raise rates—even if rates were at some form of equilibrium, say 4.5%. But rates are sitting at between 25 and 50 basis points. You may recall that back in 2012 the Fed cited a 6.5% unemployment rate as a benchmark for when they would begin to tighten. That mark was breached for the first time (in this cycle) in April 2014, but the Fed failed to tighten until 21 months later when the rate was at 5.0%.  

Kaplan, however, hedged adding that Fed may need to defer a rate hike until after its June meeting because of Great Britain’s vote on whether to leave the European Union.

That is in line with what has gone on over the last few years when a dozen data points can be cited to tighten and one hiccup causes a delay. No offense to a potential Brexit, but that is not what the Fed is mandated to base its decisions on.

The Fed President also used the word patient and gradual. As we noted in the past, six months seems like the upper limit on gradual. Once you surpass six months, it is more policy shift. The Fed tightened rates 25 basis points at its December 2015 meeting, to push the next move beyond June would raise more questions than answers. Especially since a near-consensus seemed to have been reached prior to today’s report.

One group was not fully convinced, traders. Fed Funds futures rallied sharply on the May employment report and the July 2016 contract is indicating virtually no chance of a rate increase at the June meeting (see chart).

About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.