What the Fed Will Be Watching in the Employment Report
The Fed Will Be Watching Some Lesser Known Job Stats
The July employment report will be released at 8:30 am ET and the question isn’t so much what the results will be but how much will investors react to the findings? The median expectation is that 870 thousand jobs were created versus 850 thousand in June with the unemployment rate dipping to 5.7% versus 5.9% the prior month. Once again, however, the dispersion of estimates for job growth are quite wide with a low of 350 thousand and a high of 1.2 million. The miss by ADP earlier this week at 330 thousand private sector jobs versus 690 thousand expected adds another element of uncertainty to the outcome. However, the ISM Services Index hit a new high on Wednesday with the employment component rising 4.5 points indicating solid service sector hiring. While the market heads into the report with a fair amount of doubt the bigger question is how much will it matter now that the delta variant numbers are breaking higher and the implication that has for growth? We expect a knee jerk reaction to the results— 4 to 5bps either way — but don’t see it as a trend-defining report. It’s more likely after the initial rush attention quickly returns to virus case counts.
Finally, in our podcast this week we have two of our own: Todd Patrick and Todd Davis to talk investment strategies in the current rate and economic environment and after the recent FOMC meeting. With most banks still awash in excess liquidity you’ll want to give it a listen. The iTunes link can be found here and the Spotify here.
What Constitutes Maximum Employment?
The Fed has been pretty consistent in its messaging that returning to maximum employment is a key goal before starting to hike rates, despite the recent bout of inflation that they have characterized as transitory. How best to measure maximum employment is something the market is wrestling with as the Fed remains somewhat vague on that topic. Is it simply returning to a 3.5% unemployment rate that prevailed pre-pandemic? Could be, but that could also be a bit misleading as the labor force (those working and those unemployed but looking) has undergone significant changes due to the pandemic. Namely, several million have left the labor force over the past year or more for early retirement, or to care for elderly and/or children, and thus are not counted as unemployed. The number of employed remains about 8 million below the pre-pandemic level and getting most of those jobs back is probably one criteria in defining maximum employment.
The Labor Force Participation Rate (labor force/population) is one measure that captures this labor force exodus and is undoubtedly a measure the Fed is focused on in determining a return to maximum employment. As the chart shows the current rate is 61.6% which is well off the 63.4% pre-pandemic high. Expectations for July are for the rate to edge up to 61.8%. With the delta variant causing a rebound in cases the pace of school and business re-openings is likely to be slower than thought just a month ago thereby extending the time-line to return to maximum employment. While some Fed members are getting an itchy trigger finger to hike due to inflation, we think Powell and other Fed leaders are more fixated on fully repairing the damage done to the labor force and that is likely to keep them in accommodative mode for quite some time.
Underemployment Rate Also Signals Much Ground to Make Up Before Maximum Employment
Another measure the Fed will be watching in determining a return to maximum employment is the so-called Underemployment Rate, or U-6 in BLS parlance. This captures a wider swath of the labor force by including not only the unemployed but also the marginally attached (not working and not looking currently but still wanting a job), and those wanting full-time work but working only part-time due to business reasons. By including the marginally attached it does recognize those that fell out of the strict labor force definition but would likely return to work when conditions allow.
As the graph illustrates this rate bottomed in December 2019 at 6.8% peaked at 22.9% in April 2020 and currently sits at 9.8%. Getting that rate back in the neighborhood of 6.8% is something the Fed will want to see, but while dramatic declines were made early in the recovery it’s likely the final 3% needed to return to pre-pandemic levels will be more grudging. This year started with the rate at 11.7%, so its dropped nearly 2% in half a year. Is another 2% likely for the second half of 2021? Probably not as the prior six months saw a drop of 6.3% so the law of diminishing returns is evident.
Certainly too with the rise in delta variant cases the second half of 2021 could see slower employment growth than was the expectation just a month or so ago. It does look like returning to pre-pandemic levels will take well into 2022, if not longer if case counts continue higher, and like the Labor Force Participation Rate should keep the Fed watching and waiting on hold for a return to maximum employment through much of 2022.
Agency Indications — FNMA / FHLMC Callable Rates
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