So, was this a good employment report or a bad employment report? If you are an investor, this was all good. If you are the Fed, this report is a problem. Here are my thoughts.
Headline job gains strong
The economy added 222,000 net jobs in June, which was better than the 179,000 expected. On top of that, the prior two months were revised up by 47,000. I have argued in recent columns that 160,000/month job gains is a key level. I believe below that could be an indicator that we're hitting a stall speed. Hence today's report is a relief. With revisions, this brings the 6-month rolling average to 180,000/mo. I'm feeling a lot better about that.
However, from a pure economics perspective, that was the only good thing about this report.
Unemployment rate rises
The primary unemployment number rose to 4.4% from 4.3%. You might quibble with me and argue that this was actually a good sign, as the rise was mostly on an increase in the labor force. Maybe. But for the Fed, unemployment figures prominently in their models, so this is a quandary for them. Labor force participation has been way more volatile than anything fundamental could justify. This confounds any attempt at an accurate estimate for the "real" labor force.
And if you can't really trust the denominator of the unemployment rate, you can't trust the ratio itself, either. Hence if you are inclined to believe 4.3% is worryingly low and the Fed ought to be hiking, you aren't going to be swayed by this small uptick.
However, if you are inclined to either dismiss Phillips Curve-type analysis (i.e., the idea that very low unemployment leads to inflation) or if you would prefer to actually see inflation accelerate before hiking further, this report has something for you, too.
Wage growth declines
Average Hourly Earnings rose just 0.2% in June, and the growth rate was revised down to 0.1% in May (from 0.2%). That leaves the year-over-year wage growth at 2.5%, down significantly from the second half of 2016 prints, which were mostly in the 2.6-2.8% range.
Let's step back and think about that for a moment. The most basic law of economics is that if supply is tight, then prices will rise, all else being equal. No matter what you think of the volatile labor force estimations, the lack of wage acceleration (i.e., the price of labor) suggests that labor supply isn't tight. Meanwhile, the most recent inflation-related prints have suggested that inflation may be decelerating.
If you are Neel Kashkari or other doves on the FOMC, this feels like plenty of evidence to at least pause hiking rates.
This is why this report must be frustrating for the Fed. What do you believe? That job gains are reaccelerating after a soft first quarter? That suggests the Fed is still at risk of falling behind the curve as the economy reaccelerates. Or do you take the wage data and argue that there is still labor slack, and thus still room to keep policy accommodative?
As I'm writing, the market is bear steepening, i.e., longer-term rates are rising more than short-term rates. Two-four year rates are about unchanged, while 10-years are up 2bps and 30-years up 3bps. The odds of a December rate hike (based on fed funds futures) ticked down by 2% to 51%. That's telling you the market thinks that this doesn't change much for the Fed near-term, but may result in a slower pace in 2018. The long end is getting pressure from Europe. An even somewhat slower pace of Fed hikes would result in a weaker dollar, which makes buying U.S. bonds more expensive for European buyers.
For stocks, this is the ideal report. Strong hiring suggests business confidence remains high. It validates the good "soft" data we've seen lately and is further evidence that the U.S. economy is reaccelerating. But the middling wage number means that company costs will remain contained and the Fed won't get more aggressive.
I don't entirely agree with this conclusion. We hear from enough companies about upward wage pressure being a problem to know that there is some wage pressure. It might be that the upward pressure is concentrated in lower skill jobs, and if those are the new entrants into the labor market it could be skewing the headline wage growth figure. That's probably healthy for the economy overall, but might not be great for stock investors.
The other issue with concluding that this is a good report for risk assets is that the Fed might be targeting risk assets. The FOMC minutes from this week read like the Fed is at least as concerned about low rates fostering financial instability (read: bubbles) as they are about Phillips-effects causing inflation. I've been in the camp that low rates probably aren't helping much now and we should be slowing raising them to avoid asset markets overheating. I don't think we are in bubble territory now, but I also think if we hiked a couple more times we could probably avoid ever getting there.
We should listen carefully to Fed speakers in the next few weeks. The Fed is about to enter a quiet period, so we might not get much until after the July meeting. But listen for whether they start playing up financial market valuations as a sign they are looking to still justify another 2017 rate hike.