Strong Payrolls Versus Slower Growth

The stock market could have trouble rallying further this month, as the possibility of a 75-100 BP hike at the September 20-21 FOMC Meeting is back on the table after the strong July Employment Report.  Nevertheless, this week's July CPI Report could be important in determining the market's near-term path.  A higher-than-expected print could prompt talk of a 100 BP hike if not an inter-meeting hike, a big negative for stocks.  A lower-than-expected CPI could give the rally some breathing room.

The +528k surge in Payrolls and 0.1% pt dip in the Unemployment Rate to 3.5% seemed to defy recent data, such as Unemployment Claims and Q222 Real GDP, that suggested a softening in economic growth.   But, a combination of slower economic growth and strong job gains can be explained as a difference between levels and rates of change:

What may be happening is that companies need to expand employment because /1/ the current level of economic activity is still too high relative to the level of jobs or /2/ the level of demand is greater than what is being produced.   Put another way, the earlier stimulative fiscal and monetary policies pushed demand and output to higher levels than they did Payrolls.  Now, Payrolls are catching up -- that is, closing the gap.  That gap could be about 3.5 Mn jobs, based on Job Openings data.  In this case, Payrolls could continue to post large gains for a number of months.

The strong job growth then reflects companies' efforts to catch up to an already strong level of demand.  So, most companies are not at a point of having to eliminate workers in response to a slowdown.  They need the additional workers just to meet current demand.  As a result, from the Fed's perspective, a slowdown in growth may not be enough to reduce labor market pressures sufficiently.  A recession that lowers the level of economic activity may be needed to bring equilibrium back to the labor market. 

A reconciliation of a slowdown in GDP Growth and an almost independent speedup in Payrolls results in a decline in Productivity.  It is an offset to the increases in Productivity in 2020-21.  This outcome is not good for the inflation outlook.  A decline in Productivity would boost Unit Labor Costs just as Average Hourly Earnings shows no sign of slowing wage inflation.

This week's calendar of US economic data will highlight inflation.  Consensus looks for +0.2% m/m Total and +0.5% Core for the July CPI.  The drop in gasoline prices will hold down Total.  The risks are probably balanced with regard to Core.  A pass-through of lower gasoline prices would hold down some prices.  And, there is anecdotal evidence that inventories are being reduced through price discounting.  But, higher labor costs could lift prices.  And, housing rents could speed up further, as they lag reports of slowing rents.

The other important inflation report this week will be the University of Michigan's 5-Year Inflation Expectations for Mid-August.  They were 2.9% in July, staying within their recent range.  But, the final monthly number was above the 2.8% mid-month read.  This means that Expectations were likely closer to 3.0% in the 2nd half of July.  So, the risk could be for an uptick from the July level.