Barclays – Soft May US employment unlikely to alter near-term Fed plans
Employment growth has slowed. May payroll employment growth slowed to 138k from a downwardly revised 174k in April, below our (175k) and consensus (182k) expectations. The deceleration was broad-based, as private sector employment slowed to 147k and government payrolls declined by 9k. Within the private sector, goods-producing sectors added only 16k on the month, while services employment growth moderated to 131k. Construction and temporary help services were the only categories of hiring that improved relative to April. Manufacturing payroll employment fell 1k on the month, but after five consecutive months of increases, a slowing here is not unexpected. Within services, professional and business services added 38k, education and health added 47k, and leisure and hospitality added 31k. Retail employment declined for a fourth consecutive month, although the pace of decline in April and May (both -6k) slowed from February and March.
Earnings remain soft, but income growth has accelerated in Q2. Earnings growth was also soft in May, with average hourly earnings up only 0.2% m/m and 2.5% y/y, versus our expectation for a 0.3% monthly increase. Average weekly hours held steady at 34.4, which was in line with our expectation. Altogether, employment, hours, and earnings in April and May pushed the payroll proxy in Q2 to 4.7% (q/q saar), versus 3.6% in Q1, which suggests our outlook for a rebound in consumption growth remains reasonable.
The household survey is “catching up” to the establishment report. The household survey also showed a weaker employment growth, with employment declining 233k on the month. That said, the household survey is volatile, and we prefer the 3mma as a gauge of hiring trends. There, household employment growth averaged 132k in the March to May period, about in line with the 121k in the establishment report. The unemployment rate declined to 4.3%, due largely to the drop in participation to 62.7% from 62.9% last month. Our long-held view is that the participation rate is in a sideways trend, where the recovery is pulling workers into the labor force at about the same rate as retirees are leaving the labor force. At 62.7%, the participation rate is only one-tenth below where it stood in October 2013. Hence, we view the May participation rate drop as merely volatility around a sideways trend. Elsewhere, there was improvement in most underemployment categories, and the U6 rate fell to 8.4% from 8.6%.
In our view, the sharp drop in the U3 unemployment rate this year is due largely to a “catch-up” effect in household employment. Since late last year, year-on-year growth in household employment has lagged establishment employment, which meant that the unemployment rate did not decline much even as payroll growth remained solid. As household employment has begun to catch up with establishment payrolls, the unemployment rate resumed its decline. In January 2017, for example, the 12-month change in nonfarm payrolls was 2.33mn, while growth in household employment was only 1.55mn. As of April, these numbers were 2.17mn and 2.13mn, respectively. After the weak May household survey report, the gap has widened again, suggesting the differential between the two surveys has not yet fully resolved and points to some further downward pressure on the unemployment rate in the months ahead.
No change in Fed plans for now. We do not view today’s employment report as altering the near-term Fed path. In our view, it has clearly signaled for another 25bp increase in the policy rate in June and is committed to starting to shrink the balance sheet. In addition, the Fed desires a slowing in employment growth so that it does not get too far offsides on its employment mandate as it awaits further inflation firming. At 138k, employment growth is still nearly twice that needed to keep the unemployment rate steady (assuming a flat participation rate). FOMC members may, therefore, welcome slower employment growth as a sign that Fed policy is working properly. That said, the combination of softer employment growth and weak inflation trends calls into question whether the FOMC would go ahead and raise the policy rate again in December. We maintain our call for a third rate increase at the December meeting, but that is conditional on our expectation that labor market conditions remain healthy and core inflation gradually firms.
Slower employment growth always begs the question of recession risks. In our view, employment growth is one of the stronger recessionary indicators, and slower employment growth is something we always take seriously. In past cycles, slower employment growth (relative to the recovery-level average) has preceded recessions by 9-12 months, and we would take it as a negative signal should employment growth continue to soften. However, slower employment growth at present could be related to the abating of post-election euphoria that could have led to a faster pace of hiring earlier this year. Or, slower employment in April and May could be related to seasonal factors that pulled hiring into January and February. In our view, the data are not yet conclusive, and we look to incoming figures on claims for a near-term signal on separations and labor market conditions.
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