Jobs Market: Soft Patch or Time for Policy Response?
The market had been expecting Friday’s US jobs data to be weak but the scale of the drop in employment growth in May still took many by surprise.
With total nonfarm payrolls coming in at just 54,000, some 100,000 less than the consensus, stock prices fell, the White House fretted and talk of the third round of asset buying – known as QE3 - began.
The question now is whether one weak month can be dismissed due to one-off effects like the earthquake in Japan or whether the bears have been right all along and the predictions of doom and gloom are about to be proven right.
“We are still reluctant to take the deceleration entirely at face value, partly because many of the signs of 'healing' in the private sector that encouraged us in late 2010 are still visible,” Goldman Sachs US chief economist Jan Hatzius wrote in a note to clients following the data.
“The household debt service burden has come down sharply, household credit quality continues to improve, bank lending standards are easing, and financial conditions remain accommodative,” Hatzius explained.
“Also, we disagree somewhat with the negative tone of much of the recent housing market coverage in the media, including two front-page articles in the New York Times and the Wall Street Journal last week on the renewed slide in home prices,” he added.
With little room for a change in fiscal policy, Hatizus believes the reaction to the weakening economy, if there is one from policy makers, will come from the Federal Reserve.
What Will the Fed Do?
“And sure enough, markets that not long ago were predicting rate hikes are now starting to debate QE3. But we believe that the Fed’s 'zone of inactivity' is much wider than these wild swings might suggest," he wrote.
"The hurdle for rate hikes is high, and we feel good about our long-standing view that the funds rate will remain at its current near-zero level until 2013.”
“But the hurdle for QE3 is also high, and indeed much higher than it was for QE2,” said Hatizus.
“It probably requires either a meaningful rise in the unemployment rate or flat unemployment coupled with a sharp fall in core inflation and inflation expectations.”
The Fed will be worried about the drop in payrolls from 232,000 to just 54,000 in just one month according to Paul Ashworth, the chief US economist at Capital Economics.
“We suspect that Fed officials will be particularly concerned to see the unemployment rate going in the wrong direction: it rebounded to 9.1 percent last month, from 9.0 percent in April and a low of 8.8 percent in March,” said Ashworth in a note to clients.
Dismissing the impact of the Japanese quake, Ashworth is worried by how broad based the drop in job creation was.
“It is now pretty clear that the economy ran into a brick wall last month. We probably will see growth rebound in the second half of the year, as commodity prices drop back and any Japan-related disruptions unwind,” he said.
“For that reason we don't expect the Fed to act immediately. Nevertheless, the extent of this slowdown is becoming a big concern, particularly with a potentially big fiscal consolidation on the way and we wouldn't rule out a QE3 either later this year or in early 2012,” Ashworth added.
Others warn that one set of poor data do not make a summer.
“Following the euphoria after the April job report, these numbers are a reminder that we should not put too much emphasis on one set of figures,” said Allan von Mehren, the chief analyst at Danske Bank in Copenhagen in a research note.
“The data will add to the growth scare. However, we still believe that we are witnessing a soft patch and that growth will recover again in H2. Payrolls are expected to reach an average of 200,000 in the summer. The rise in the employment index for the ISM non-manufacturing in May - also released today – underpins the fact that job creation is still intact,” von Mehren added.
Over at HSBC chief US economist Kevin Logan believes the Japanese quake was a factor but also points to a worrying loss of confidence.
“The first factor should prove to be temporary, as manufacturers should gradually return to previous production levels by the end of Q3. The second shock could prove to have more persistent negative effects, and the weak report raises more concerns about the underlying strength of the economy,” said Logan in a research note.