Previewing Tomorrow’s Payrolls: Watch Out For Short-End Fireworks

As the world awaits the next in the series of “most important jobs numbers ever,” which has now been shown as only relevant to the degree by which it moves the S&P 500 higher (or god forbid lower), consensus expectations are for a goldilocks 180k gain in jobs and flat 4.9% unemployment rate. The market will be looking to see if the Fed’s recent optimism surrounding labor market conditions (despite a collapse in their own LMCI) are justified and if the employment figures of July and August demonstrate a new trend in conjunction with June ahead of the September meeting… and of course the ‘election adjustment’.

Consensus Expectations:

• US Change in Nonfarm Payrolls (July) M/M Exp. 180K (Prey. 287K, May. 11K) – close to the average of 172K for the first half of the year.
• US Unemployment Rate (July) M/M Exp. 4.8% (Prey. 4.9%, May. 4.7%)
• US Average Hourly Earnings (July) M/M Exp. 0.2% (Prey. 0.1%, May. 0.2%)

So just ignore this… It’s probably nothing…

Goldman expects a 190k increase in nonfarm payroll employment in July, slightly above consensus expectations for a 180k gain.

Most labor market indicators were roughly in line with their recent trends, though a couple of key indicators were somewhat stronger in July.

Arguing for a stronger report:

• Job availability. The Conference Board’s labor differential—the difference between the share of consumers saying jobs are plentiful vs. hard to get—moved back into positive territory in July, rising 1.2pt to +0.7. The index remains below the highs reached in the last few expansions.
• Jobless Claims. The four-week moving average of initial jobless claims leading into the payroll reference week fell 9k to just 258k in July, and claims during the survey week were just 252k. While seasonal adjustment is often challenging in July due to the annual auto plant shutdowns, we nonetheless take some positive signal from the very low recent level of jobless claims.

Neutral factors:

• Service sector surveys. The employment components of the service sector surveys were mixed in July. The ISM non-manufacturing survey (-1.3pt to 51.4) and the Richmond Fed survey (-5pt to +12) declined, while the Markit PMI, NY Fed (+3.9pt to +6.9), and Dallas (+1.8pt to +3.8) surveys improved. Service sector employment rose 256k last month and has increased 166k on average over the last six months.
• Manufacturing surveys. The employment components of the manufacturing surveys were also mixed in July. The Markit PMI, Chicago PMI, Philly Fed (+9.3pt to -1.6), Richmond Fed (+5pt to +6), and Dallas Fed (+8.9pt to -2.6) surveys improved, while the ISM manufacturing (-1pt to 49.4), NY Fed (-4.4pt to -4.4), and Kansas City Fed (-1pt to -5) surveys worsened. Manufacturing employment growth declined by an average of 4k over the last six months, but rebounded to +14k in June.
• ADP. ADP reported a 179k gain in private payroll employment in July, roughly in line with the increases seen in May and June. Service-sector job gains softened a bit to 185k, manufacturing employment rebounded by 4k, construction employment fell 6k, and energy-sector employment appeared to fall by 4k, the smallest reported decline in that sector since 2014.
• Online job ads. The Conference Board’s Help Wanted Online (HWOL) report showed increases in both new and total online ads in July, though to levels that remain below those seen earlier this year. We put only limited weight on this indicator at the moment in light of recent research by Fed economists that argued that the HWOL ad count—which had departed significantly from the job openings figures in the official Job Openings and Labor Turnover Survey (JOLTS)—has been influenced by price increases for online job ads.
• Job cuts. According to the Challenger, Gray & Christmas report, job cuts fell a touch on a seasonally adjusted basis in July. Announced job cuts in the energy sector spiked to 18k in July, indicating that energy job losses likely have a bit further to go.
• Weather. Weather effects on the monthly payroll numbers were a big story in the first half of this year, as we noted last month. At this point, however, the large swings in weather-sensitive industries are likely behind us, and we have found in past research that weather does not have a statistically meaningful effect on payroll growth from June to October.

We expect the unemployment rate to remain at 4.9% in July from an unrounded 4.899% in June, but see the risks as tilted to the downside. The headline U3 rate rose 0.2pp in June, while the broader U6 underemployment rate fell 0.1pp to 9.6% as a result of a very large drop in involuntary part-time employment. In our recent labor market status report, we estimated that there is about 0.5pp of broad slack remaining in full-time equivalent terms. With trend employment growth still running at roughly double our 85k estimate of the breakeven rate, we expect the labor market to reach full employment by early 2017 and to surpass it thereafter.

Average hourly earnings for all workers are likely to rise 0.3% in July, in part reflecting favorable calendar effects. This should leave the year-on-year rate unchanged at 2.6%, though we see the risks as tilted to the upside. Our wage tracker—which aggregates four measures of wage growth—has accelerated to 2.8% year-on-year in our preliminary Q2 estimate, a sign that diminishing slack is boosting wage growth.
 

Market Reaction

As ever with the NFP release, the headline is likely to garner much of the initial focus with algorithms and fast money moves jumping on any large discrepancies. Participants are likely to view the jobs report with a wide context, as recent months have seen two extreme numbers on either side of the spectrum, and any substantial revision to last month’s large beat could weigh on the USD. However, how the report is received will ultimately be decided on whether it can justify more of the few calling for a September hike and to do so a very strong report must be seen.

And BNP’s strategists Timothy High and Daniel Tangho warn risks to short-end yields appear underpriced…

Markets continue to discount the possibility of a rate hike in September; the Fed funds market estimates there is a 20% chance.

A strong NFP could push 2y Treasury yields higher by 20bp or more, which would match yield levels seen before the May NFP report derailed the odds of a hike in June or July.

The 2y Treasury yield was 0.90% in mid-May when market participants assigned a 55% probability of a July rate hike. While a weak NFP report could derail a September hike, a strong report is likely to force the markets to re-evalute the situation, in which case a 20% probability of a September rate hike is too low: 55% is more appropriate, and the 2y Treasury yielding about 0.90% is also appropriate.