The jobs number was great, but it’s all about the Fed now

This morning, I gave you an initial reaction to the jobs number, saying:

A bad number won’t change the Fed’s forward guidance because the Fed has a tightening bias. But that bias means that a good number could tip us toward four rate hikes in 2019 from three.

Let me give you a more in-depth view now.

Market reaction

Before the number came out, I didn’t expect a big market reaction. But I think we are seeing the market move to my view more strongly than I anticipated because the 10-year is up to 3.214% on the back of the bullish jobs report. The big difference is that we are seeing a bear steepening, with the 10-year trading 30 basis points wide of the 2-year. I see that as a mildly positive signal regarding economic expectations even though I am personally expecting the US economy to slow.

The stock market is also off on the news, with the Dow down almost 200 points right now. I’m still not too concerned about equities here though. The near-term US economy is good enough to prevent a repeat of the meltdown we saw in October.

The key, though, from a market perspective is that, not only did we have the market breakdown at 3.25% that I had been talking about since February, but the bond market has also adapted to this new level really quickly. 10-year yields are now back to within 4 basis points of the meltdown trigger level. So, the next stop is 3.50% for the 10-year.

Let’s talk about jobs

As far as the report goes, here are some highlights:

  • The headline number of 250,000 jobs added to nonfarm payrolls was eye-popping, especially because we should expect the pace of job growth to slow this late into the cycle. As the Labor Department put it, “Total nonfarm payroll employment increased by 250,000 in October, following an average monthly gain of 211,000 over the prior 12 months.” That’s big.
  • But more important was wage growth. Average hourly earnings for private workers was up 3.14% from year-ago levels. That’s a decent number. And it will have the Fed thinking about moving to four rate hikes in 2019, instead of three.
  • The unemployment level at 3.7% was a push. The Fed also has 3.7% penciled in on its summary of economic projections for year end. They have 3.5% for year-end 2019 and 2020. And they see 4.5% as the long-term stable rate. So that says we risk going below the Fed’s projected level for year end. And we are also well below the level at which the Fed thinks inflation could be stoked.
  • Here’s a great data point from macro strategist George Pearkes about people coming back into the labor force: The prime-age employment to population ratio is now the highest since March 2008 at 79.7%. That’s an 85th percentile level dating back to 1948, a 78th percentile level dating back to 2000, and 2.2% below the record from April 2000. It’s the biggest advance over the last 5 years since 1989. For the Fed, that should speak to reduced labor market slack.
  • On reduced slack, there’s even more bullish data.Labor force participation and the employment-population ratio rose by 0.2 percentage points to 62.9% and 60.6% respectively. And the expanded U6 level of unemployment came in at 7.4% versus 7.5% previously.

Now, the October data may be non-indicative of trend because  of distortions from hurricanes both this year and last. But the composite picture is of a labor market in which jobs are being added at a robust clip, wages are increasing nicely and slack is falling quickly. To me, this speaks to an accelerated Fed hike timetable because inflation is above target and unemployment is well below target.

The Fed may talk about slow-walking their hikes. But the reality is that this report means that at the margin their slow-walk will pick up its pace.

Longer-term outlook

Look at the following chart

NFP through October 2018.png

What it shows you is that in each business cycle, the net addition of jobs peaks mid cycle. In this cycle, we had a peak of 3.127 million jobs added in the previous 12 months in February 2015. The shale bust took hold and caused that number to plummet to 2.018 million as late as September 2017. But the combination of a mid-cycle recovery and a boost in stimulus from Trump has caused the numbers to move higher ever since. We are now at a net add of 2.516 million, slightly down from September.

The key here, though, is that we are not going to re-achieve the peak. The peak is done. We are now in the terminal phase of this cycle. And are expectation should be for diminishing gains for job growth.

The question is how the Fed will see this. The danger here is twofold: there’s the traditional Janet Yellen worry that the Fed doesn’t tighten enough and is forced to accelerate excessively later on. I think we can eliminate that concern because Powell has accelerated the timetable. But then, there also a concern that the Fed overplays its hand and tightens too much, unaware at how much of a drag its policy tightening is already having on credit markets.

For now, the near-term outlook remains bright. We could even see unemployment drop below the Fed’s projected year-end level. But, the longer-term outlook for the US is more muted and the Fed is likely to accelerate the pace of rate hikes going forward.

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