Weak May Job Growth -- Soft Economic Growth or Catch-Up?

The question for the Fed and markets is whether the weak April-May Payroll growth reflects soft economic growth in Q216 or just catch-up to the strong job growth seen in Q116.  It is probably a combination of both:

1.  The job growth in Q126 was excessive relative to the 0.8% Q1 Real GDP Growth, so the weak job growth in April-May could have just brought the level of jobs better in line with the level of GDP -- and this weak job growth understates Q2 GDP Growth. 

2.  But, there are other reasons to think that the expected pickup in Q2 GDP Growth will be only modest.  So, the Fed may very well be on hold until after the November elections.

If economic growth were, in fact, as weak as the job growth suggests, the Unemployment Rate should have risen.  Instead, the Unemployment Rate dropped to 4.7% from 5.0%.   While the drop in the Rate resulted from a drop in Labor Force, this could have reflected a quirk of the small Household Sample Size.  So, while many Street Economists will likely dismiss the drop as reflecting discouraged workers, this may not be the case.  The broader measure of unemployment -- U-6 -- was unchanged m/m at 9.7%.

That said, the pickup in Q2 Real GDP Growth may very well disappoint the Fed's expectations for it.  The April FOMC Minutes showed that the Fed staff lifted their forecast for Q2 Real GDP after admitting that Q1 GDP appeared to have come in weaker than expected.  This improved outlook for Q2 GDP got support from some strong April economic data, which had led to the Atlanta Fed's GDP Model projecting 2.9% (q/q, saar) for Q2 Real GDP.   However, the model lowered its projection to 2.5% after Wednesday's reported drop in April Construction Spending.   And, I think that May Retail Sales --Total, Ex Auto and Ex Auto/Ex Gasoline -- (due June 14 -- also the first day of the 2-day FOMC Meeting) could be weak, as well, based on some anecdotal evidence from retailers.   So, I would not be surprised if the Atlanta Fed Model's projection is cut again.  With Q1 GDP Growth of 0.8%, the H116 Real GDP Growth would be under the Fed's target of 2.0%.

If Q2 GDP Growth disappoints, the message from the sluggish growth since Q415 would be that the underlying momentum in the economy is lower than the Fed believes.  It would probably be a mistake for the Fed staff to push ahead stronger growth, as it did after the weak Q1 GDP, particularly since uncertainty over the November Presidential Election could weigh on business and household spending decisions in Q316.  So, a Fed rate hike may not happen before the elections.