What's Important in the June Employment Report

The stock market will face month-/quarter-end window dressing as well as key US economic data this week.  The seasonal selling at this time appears to have occurred earlier than usual, so this "technical" factor will probably be a non-event this week.  While the markets and news reports focus on inflation data as critical for Fed policy, this is not correct, as the Fed leadership firmly believes currently high inflation prints will be transitory.  What is more important is the Employment Report, as these officials appear to be committed to eliminating the labor market slack that resulted from the pandemic.  From this perspective, the June Employment Report is not likely to stand in the way of a strong earnings season this summer.

The most important part of the June Employment Report, consequently, is the Unemployment Rate.  And, not only the overall Rate but the various sub-measures, as well.  Fed officials have stressed their desire for all groups to experience labor market improvement.  Their goal is not likely to have been achieved in June.  The consensus estimate of a 0.1% pt m/m decline in the Rate to 5.7% from 5.8% would leave a large 2.0% pts needing to be eliminated in coming months (see table below).  So, a near-consensus +675k jump in Nonfarm Payrolls would not likely be enough to unsettle the Fed's commitment to steady easy policy.  

Besides the overall Unemployment Rate, Fed officials have underscored their goal to achieve a broad reduction in labor market slack.  As of May, the only major sub-group that has made up the lost ground over the pandemic was Teen-Agers.  Perhaps their success in getting jobs stems from the absence of adults who stayed unemployed in order to receive the supplemental benefits.  With many states having stopped these benefits, and Continuing Claims beginning to fall sharply, adult unemployment should fall while the Teen-Age Rate may move back up.

         Unemployment Rate and Sub-Measures Versus Pre-Pandemic Lows (level, percent)

                                        May 2021                    February 2020

Total                                 5.8                                3.5               

Adult Male                       5.9                                3.2

Adult Female                   5.4                                3.1            

Teen-Age                         9.6                              11.5

Black                               9.1                                6.0                

Latino                              7.3                                4.4

There are some downside risks to the +675k consensus estimate of June Payrolls.  This is because the recent surge in Leisure and Hospitality jobs may slow, as was the case in this component of May Consumer Spending.  A slowdown in this jobs segment would offset speedups elsewhere, the latter suggested by the Claims data.

Other parts of the Employment Report could provide important evidence on whether economic growth will slow on a q/q basis in Q321.  In particular, if the Nonfarm Average Workweek pulls back from its very high 34.9 Hour level, Total Hours Worked could be subdued even with a large Payroll gain.  The June level of THW will indicate the take-off point for the subsequent quarter.  While consensus looks for a steady Workweek, there is no reliable evidence on which to base a forecast.

Consensus looks for a slowdown in Average Hourly Earnings to 0.3% m/m from 0.5% in May.  The market should take comfort if this estimate turns out to be right, as it would suggest labor cost inflation is not accelerating.  It is still above the 0.1-0.2% trend seen pre-pandemic, however.

Other US economic data this week should have little market impact.  Consensus looks for little change in the June Mfg ISM from 61.2 in May.  Other manufacturing surveys have been mixed, but all show a still strong sector.  Consensus expects a speedup in May Construction Spending to +0.4% m/m from +0.2% in April.  The stoppage of the "Border Wall" in Texas has weighed on this Spending in recent months.

 

The Fed Or A Bout of Seasonal Weakness?

Most commentaries attributed last week's stock market sell-off to a more hawkish Fed projection of the fed funds rate.  Such attribution is questionable, as discussed below.  What makes more sense is an early start of seasonal market weakness in late June that tends to last for 10 days or less and subsequently is quickly made up. 

Commentators' attribution was based on an upward shift in the number of FOMC participants who think it likely the funds rate will rise in 2022 and 2023.  The problem is that these long-term forecasts are not reliable and should be taken with a grain of salt, as Fed Chair Powell said in his post-meeting conference.  In fact, the thrust of his entire post-meeting new conference was the importance of achieving the Fed's goal of full employment -- an argument for continuing easy policy.  He gave reasons why the currently high inflation prints are likely temporary.  And, he mentioned that some of the longer-run factors holding down inflation -- foreign competition,  technology, etc. -- would probably continue to be in effect in coming years.

The  FOMC participants expectations of the funds rate through the next two years is shown in what's called the "dots" chart -- because there is a dot for each participant's expectation.  The "dots" chart showed the number of FOMC participants who expect the funds rate to be hiked in 2022 rose to 7 from 4 in the prior March chart.  The number rose to 13 from 7 in 2023.  Eleven participants did not expect any rate hike in 2022 and five in 2023.   Powell seemed to dismiss the significance of the rate forecasts for being highly uncertain.  The Statement, itself, essentially did not change, implying steady easy policy at this point.

While many commentators mentioned the higher growth and inflation in the Fed's Central Tendency Projections, they failed to realize that most of the increases reflected the high prints already seen.  My calculations suggest that the upward revision in the Fed's projection of the 2021 Core PCE Deflator to 2.9-3.1% (Q4/Q4), for example, assumes about a 2.0% annualized rate of increase over H221.  This is not an excessive pace and puts it in line with the Fed's longer-run projection over the subsequent two years.  The Fed's 2021 projection of 6.8-7.3% (Q4/Q4) Real GDP Growth assumes 5.3-6.3% over H221, using the Atlanta Fed model's current estimate of 10.3% for Q221.  The H221 pace would be substantially slower than the 8.4% pace of H121.  The Fed sees Real GDP Growth falling back toward trend in the following 2 years.

Fed officials will have opportunities to clarify their policy stance this week.  The two most important should be Powell, who testifies on the coronavirus and the economy on Tuesday, and NY Fed President John Williams on Monday.  Both represent Fed leadership and are likely to emphasize the steadiness of easy monetary policy, the transitory nature of recently high inflation figures and the Fed's goal of full employment.  Other Fed District Bank Presidents will speak as well, including St Louis Fed President Bullard, who gave a hawkish spin to the meeting's results on Friday.  He appears to be in the minority of FOMC participants, however, as he said he expects a rate hike in 2022.

While there is not enough significance in the outcome of last week's FOMC Meeting to warrant a major negative stock market reaction, the S&P 500 Index has a history of short-lived pullbacks towards the end of Q2.  To illustrate using the past 5 years, the Index peaked around June 20 and then fell for 10 days or less (see table below).  The decline could be sizable or modest.  However, they were all erased by early to mid July.   This seasonality appears to be well known, as it was discussed on CNBC.  This may explain why it began a bit early this year.  

                  Seasonal Weakness in S&P 500 Index

 Peak            Trough        Peak Regained        Peak-Trough Change   

 6/19/20        6/29/20        7/2/20                            -3.9%

 6/21/19        6/27/19        7/1/20                            -1.1%

 6/20/18        6/28/18        7/9/20                            -2.6%

 6/20/17        6/28/17        7/17/17                          -0.9% 

 6/24/16        6/28/16        7/1/16                            -4.6%

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6/14/21                                                                   -2.1% to date

This week's US economic data are expected to paint a picture of strong demand in manufacturing and mixed demand for housing, along with high inflation.  There are downside risks, however.  Consensus looks for a 2.7% m/m rebound in May Durable Goods Orders, with Ex Transportation up 0.7%.  But, some of the recent strength could have overstated trend, and there could be payback.  Consensus also looks for an increase in May New Home Sales but a decline in Existing Home Sales.  The decline in May Housing Permits, however, suggests a decline in New Home Sales, as well.  Consensus looks for -2.5% m/m in May Personal Income, as government transfer payments unwind.  This could underscore Fed Chair Powell's comment that an end to fiscal stimulus is one reason to expect slower economic growth ahead.  The consensus estimate of +0.3% m/m in May Consumer Spending is modest.  But, March and April Consumer Spending should be revised up, as were Retail Sales in those months.  The Core PCE Deflator is seen at +0.6% m/m, versus +0.7% in April. 

 

A Benign FOMC Meeting Should Support Stocks

The stock market rally should continue through this week's FOMC Meeting, which should issue a Statement not much different from prior ones.  The Statement should imply that the Fed is not ready yet to begin stepping on the brakes or even hint they will soon do so.  Following the meeting, stocks are likely to move up into month-/quarter-end, particularly since the subsequent Q221 corporate earnings season should be strong.  This week's US economic data are expected to show gains, thereby supporting the stock market rally.

There are two reasons why the Fed is likely to keep its easy money policy now.  First, labor market slack remains well above pre-pandemic levels.  The Fed has indicated elimination of this gap is one of their goals.  Second, much of the price surge seen in the April and May CPI's can be attributed to temporary post-pandemic adjustments, in line with the Fed's view of near-term inflation.  The dip in the University of Michigan 5-Year Inflation Expectations to 2.8% in mid June from 3.0% in May should have been a relief to Fed officials, as it suggests longer-run inflation expectations are contained.   The measure is back to the top of its recent 2.3-2.8% range.

Last week's drop in longer-term Treasury yields despite the high CPI also should alleviate concern officials might have regarding inflation expectations.  To be sure, it is conceivable the inability of President Biden and Republicans to agree on an infrastructure bill was behind the drop in yields (as well as the increase in stocks).  It meant the markets -- both Treasuries and stocks -- do not have to move in ways to crowd out other spending ahead.  It remains to be seen whether the latest $1 Tn bipartisan Senate deal gains traction.  

This week's US economic data are expected to post modest gains.  These include May Ex Auto Retail Sales, Industrial Production and Housing Starts.  Such prints would support the stock market rally without upsetting the Treasury market.  A high May PPI print is likely to be discounted, as was the CPI.  And, it would be a market positive if it printed below the 0.6% m/m consensus (for both Total and Core).  

The most interesting release could be Unemployment Benefit Claims.  Last week's report showed that Continuing Claims finally fell sharply.  This week's report will provide evidence whether the sharp decline was the start of a downward trend.  The ending of supplemental benefits in some states could have pushed unemployed people to get jobs.  If so, it would bode well for June Payrolls.

Too Soon to Worry About Fiscal and Monetary Policy

The stock market will navigate through two policy-related events over the next week and a half -- /1/ potential resolution of the negotiations regarding President Biden's infrastructure proposal and /2/ the June 15-16 FOMC Meeting.  The potential market negatives surrounding the two are probably further ahead. 

The Administration already has moved closer to the Republican proposal regarding the amount of so-called infrastructure spending.  But, the two sides differ markedly on how to fund the spending.  The problem for the markets -- both stocks and Treasuries -- is whether and when to move in ways to offset the economic boost from the spending.  In other words, tighter financial market conditions will likely be needed to crowd out private spending if higher taxes do not restrain consumption or business investment sufficiently to free up resources for the increased spending on road and bridge repair, etc.   With the spending expected to be used over 8 years, and given the typical lag between passing the legislation and starting construction, the need to crowd out private spending would not seem to be imminent.  Moreover, if tax hikes are significant, the immediate economic impact could be negative.

The stock market appeared to ease its fear of near-term Fed tapering after Friday's May Employment Report.  And, there was good reason to do so.  Most of the +559k m/m increase in Nonfarm Payrolls was one-off, tied to the re-opening of the economy.  Job gains elsewhere were modest.  While the Unemployment Rate fell to 5.8% from 6.1%, it remains 2+% points above the pre-pandemic lows.  The Teen-Age Unemployment Rate was the only one of the various sub-measures that fell below that earlier low.  The 0.5% m/m increase in Average Hourly Earnings was high, but less than the 0.7% in April.  And, it is conceivable it reflected adjustments to the re-openings after having been held down during the pandemic.  So, the Fed can wait to see if wage inflation settles down later this year.   The Statement is likely to indicate no change in the amount of bond purchases. 

With the Fed taking a wait and see attitude, this week's release of May CPI could have an asymmetric impact on the markets.  Consensus looks for +0.4% m/m for both Total and Core.  A below-consensus print should be a positive for both stocks and Treasuries.  But, an above-consensus print may very well be ignored.