Article / 02 September 2016 at 4:54 GMT

3 Numbers: Good US jobs report needed for September rate hike

Blogger / MoreLiver's Daily
  • US August jobs key for the Fed's September meeting
  • UK construction PMI in recessionary waters but might surprise
  • US core factory orders to continue small increases but outlook uncertain

By Juhani Huopainen

Today’s main event is once again very clear – the US August jobs report, nonfarm payrolls.

US markets will be closed next Monday, and that could show up in today’s price moves as investors adjust their positions ahead of the long weekend.  This could also lead to investors overreacting to the jobs report. 

 The key figure to watch in the US jobs report will be average hourly wages. Photo: iStock

My overall guess is that the jobs report will be good enough for a rate hike in September, if the Federal Reserve really wants to do it. While rate-hike expectations might increase from current levels, they are already fairly priced and the USD has strengthened.

On the USD we are getting close to a “buy the rumour and sell the payrolls” kind of a situation. Thursday’s move in GBPUSD, EURUSD and USDJPY, and the overall daily charts all look like USD strength could be behind us.

Next week brings us the European Central Bank’s policy-setting meeting and August service purchasing manager indices. The ECB meeting should keep the EUR under pressure during the early part of the week as investors try to avoid being hit by some surprise announcement by President Mario Draghi.

Federal Reserve Bank of Richmond President Jeffrey Lacker discusses “Interest Rate Benchmarks” before the Virginia Association of Economists and Richmond Association for Business Economics at 1700 GMT.

UK August Construction Purchasing Managers Index (0830 GMT). UK’s economic data has provided plenty of positive surprises after the Brexit referendum. Yesterday’s manufacturing PMI beat expectations in a grand way, and GBP rallied.

The construction sector has been the hardest hit, as the overall trend had been negative for couple of years already, new real estate tax decreased demand and lowered prices, and many of the foreign buyers from oil-producing countries have been hurt by the lower oil price, and in case of Russia, by economic sanctions.

The construction PMI was 45.9 in July, and the consensus forecast is for a small rise to 46.1.  After Thursday’s manufacturing surprise, investors are probably hoping for a higher reading, and a number close to the consensus forecast could be a disappointment as it would remind everyone that the UK construction sector will not act as source of growth in coming quarters.

Next week brings us the Halifax house prices and the all-important service PMI – services are a big chunk of the economy, and the PMI has been hit heavily following the Brexit vote.

Fortunately, lending and retail sales have held up pretty well, so there is a notable chance of a positive surprise waiting for us next week. The press release will be here.

US August Employment Report (1230 GMT). Following a weak report in May, the June and July reports have been relatively strong. June saw jobs increasing by 292,000 and July by 255,000 – both numbers are close to the top of the range of what we’ve seen during the past five years.

After two above-average months, some sort of mean reversion to slightly lower levels should be expected and would not be bad news.

US payrolls
 Chart source: Saxo Bank

The consensus forecast is for jobs to increase in August by 180,000. The ADP National Employment Report released yesterday showed a monthly increase of 177,000, but the correlation between the ADP and the establishment report is often weak on a monthly basis.

If history is any guidance, the ADP report is the less volatile and more “correct”, but investors tend to trade on the basis of the establishment report released today.

The expected payroll increase is considered to be high enough for the Federal Reserve to consider a rate hike, maybe as early as September 21. The key figure to watch will be the average hourly wages, which in July had increased 2.65% from a year ago, the highest growth rate since 2009.

Looking at the bigger picture, the payroll change from a year ago is a good metric. It is less volatile than the monthly changes and makes trends easier to spot. In the eighties and nineties we had plateau-type periods when the growth rate was between two and four million. Jobs growth remained high and never came even close to zero.

The recovery after the dotcom bust was different – after the initial recovery the growth rate didn’t stabilise into range, but instead turned abruptly lower as the financial crisis begun.

The current recovery is similar to the two “well-defined” recoveries, which should be good news. Unfortunately, the current “recovery box” is soon six years old, and the previous two boxes lasted 7-8 years. If the Fed plans to hike, it better get a move on before we hit the next recession.

Payrolls, change from year ago. Notice the lengths of the recoveries:
Payrolls long
 Chart source: Fred

The labour force participation rate has trended lower during the whole recovery. The rate shows the share of people aged 16 years and over who are employed and those unemployed who are looking for a job. 

This means that those not in the labour force have either stopped looking for a job (discouraged workers), have become stay-at-home parents or have reached retirement age (demographic shifts affect the participation rate).

Participation rate's trend is slowing down, maybe even turning higher:
US participation rate
Chart source: Saxo Bank

A lower participation rate is often seen as a sign that there is more slack in the labour market than the low unemployment suggests. The Fed shares this view, but also understands that a lower participation rate is not automatically a sign of slack that requires easy monetary and fiscal policy.

The Fed’s policy is not decided by the headline unemployment number but by the amount of slack in the labour market and wages.

Thus, understanding the participation rate better could help understand the Fed’s actions in this tightening cycle. It might be slow and erratic, but the Fed is definitely in a tightening cycle. For more on the participation rate, see this chart from 2014.

During the past three years or so, the participation rate’s rate-of-decline has been decreasing – the rate is not falling as fast as it used to. Such behaviour is often seen in economic time series  before a trend reversal.

After the September 2015 bottom, the participation rate has actually exhibited some short-term positive momentum. It could be a fluke, but could provide a way for the Fed to persist with its hiking cycle in 2017, as evidence of no slack becomes clearer.

US July Factory Orders (1400 GMT). Factory orders fell 1.5% in June and are expected to have increased 2% in July. The core orders, which exclude transportation, increased 0.4% in June, being the fourth consecutive monthly increase.

Before that, orders had decreased almost eight months in a row. Yesterday, the August ISM manufacturing index fell to 49.4, while a reading of 52 was expected.

US manufacturing was considered to be in a recession very recently, so there should be no panic this time around – investors will probably view this as oil and US dollar-related, and that the recovery is simply “delayed” by such factors.

– Edited by Susan McDonald

Juhani Huopainen is a blogger and a macro analyst at MoreLiver’s Daily. Follow Juhani or post your comment below to engage with Saxo Bank's social trading platform.


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