Fears of Turn in Labor Market Eased

The June jobs report was solid, easing fears that the highly disappointing May report reflected a discrete change in the direction of the labor market. (Click here for our reaction.) While that takes a bit of pressure off the Fed to cut as soon, we think that the case for easing—as set out by FOMC participants—remains essentially intact and that there is a high probability of a cut at an upcoming meeting, either in July or  September. We continue to expect the FOMC to cut rates by 25 basis points in July, but it’s now a closer call.  We think the market is correct to have substantially reduced the probability attached to a larger, 50-basis 

point cut in July. 

Powell will appear before congressional committees on Wednesday and Thursday this week to give his semiannual monetary policy testimony. We expect that his basic story will be very similar to that conveyed at his June press conference and subsequent remarks from policymakers—namely, that there is a solid case for a slightly easier policy. He may note that the resumption of U.S.-China trade talks and postponement of a  previously threatened further tariff hike on Chinese imports removed one immediate, particularly severe downside risk to the outlook; however, he will surely emphasize that the outlook continues to be characterized by considerable uncertainty, including concerning trade policy. It wouldn’t surprise us if Powell is interpreted as suggesting that a July cut is less of a certainty than the market thinks. Because we don’t see  FOMC participants as decided on a July cut, we don’t think Powell would want to further reinforce expectations of a cut (although we think that will be the eventual outcome). 

Policymaker Remarks 

Mester (Jul. 2) laid out her arguments against a near-term rate cut. We suspect at least a few others on the  FOMC share her views. She explicitly disagreed with the idea that downside risks alone would warrant easing:  “Cutting rates at this juncture could reinforce negative sentiment about a deterioration in the outlook even if  this is not the baseline view [and] could also encourage financial imbalances given the current level of interest  rates, which would be counterproductive.” She was doubtful that a rate cut would do much to improve the inflation outlook. And she was also skeptical that market expectations of a rate cut represented a valuable signal for the FOMC: “We want to infer something from that, but some of its noise and some of its signal.  If you always react to the market, it’s self-reinforcing and you’ll never get a signal.” Her baseline was  continued good performance of the economy, although she said, “There is some chance that an alternative, the weak-growth scenario could be emerging.” Her criteria for a rate cut were: “a few weak job reports, further  declines in manufacturing activity, indicators pointing to weaker business investment and consumption, and  declines in readings of longer-term inflation expectations.” Note that this list does not include the downside risks that other policymakers have suggested. 

Nowcasts (2019:Q2) 

Source Current One Week Ago Two Weeks Ago
Atlanta Fed GDPNow 1.3% 1.5% 2.0%
New York Fed Staff Nowcast 1.5% 1.3% 1.4%
CNBC/Moody’s Survey 1.7% 1.8% 1.9%

Recent Data 

The overall trade balance was reported to have widened more than expected in May. It appears that net exports subtracted substantially from real GDP growth in Q2. Construction spending declined substantially in  May, but that disappointment was mitigated by an upward revision to April’s figure. Private construction spending has continued to be weak, while public construction spending has grown strongly so far this year,  notwithstanding a decline in May. The ISM manufacturing report for June showed only a slight further decline in the headline composite, but there’s been a clear and sustained decline from the expansion highs reached in late 2018. The ISM nonmanufacturing composite has fallen as well in recent months, but that decline has been less pronounced. 

Last week’s jobs report for June was solid, providing an important counterweight to other recent incoming data that have led tracking estimates of real GDP growth in Q2 to fall to well below 2% once again. We see it as easing fears that the highly disappointing May report reflected a discrete change in the direction of the labor market. Payrolls increased 224K in June, much more than expected. Over the last three months, job gains have averaged 171K per month, very close to the average pace so far this year. The unemployment rate continues to move within a narrow band at very low levels. It edged up to 3.7% in June as the participation rate increased a tenth as well.

Release Period Actual Consensus Revision to  Previous ReleasePreviously  Released Figure
ISM Manufacturing Jun 51.7 51.0 — 52.1
Construction Spending MoM May -0.8% 0.0% 0.4% 0.0%
Wards Total Vehicle Sales Jun 17.30m 17.00m — 17.30m
Trade Balance May -$55.5b -$54.0b -$51.2b -$50.8b
Core Capital Goods Shipments MoM May F 0.6% — — 0.7%
Core Capital Goods Orders MoM May F 0.5% — — 0.4%
ISM Non-Manufacturing Index Jun 55.1 56.0 — 56.9
Change in Nonfarm Payrolls Jun 224k 160k 72k 75k
Unemployment Rate Jun 3.7% 3.6% — 3.6%
Average Hourly Earnings MoM Jun 0.2% 0.3% 0.3% 0.2%
Average Hourly Earnings YoY Jun 3.1% 3.2% — 3.1%
Labor Force Participation Rate Jun 62.9% 62.8% — 62.8%

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