It is hard to stick to the discipline of never reading too much into a single data point when in an initial reaction to this morning’s Nonfarm Payroll numbers, they were nothing short of superlative. The unemployment rate dropped again, to 5.5%, with an impressive 295,000 net new jobs created despite the lousy weather; all told that is translating into a 288,000 a month average over the last three months and more than 200,000 a month for the last twelve months. Is this a great country or what?
But without reading too much into it, we wanted to make a few points:
*** A single number does not a trend make, naturally, though this is one of those single numbers that will boost the confidence among a solid majority of the Federal Open Market Committee that they should adjust the forward guidance language in the March statement. We think it is almost certain the patience language will be dropped or adjusted, to leave no doubt June is a “live” meeting for a possible first rate hike. That June optionality the Fed has been so keen to create, in turn, should be respected and priced accordingly. ***
*** The final threshold to be crossed for that first rate move, however, is not the gains in the labor market data alone, but that the FOMC should be “reasonably confident” the forecast that core inflation is moving back to a mandate-consistent around the 2% level — and that firmer evidence is still lacking. So for now, the odds on the anxiously anticipated rates lift-off are probably still evenly balanced between June and September, even if the odds do feel to be nudging towards June (SGH 2/24/15, “Fed: Nothing to Lose but their Chains”). ***
*** We also doubt the Fed is getting too worked up about the absence of wage growth in the numbers this morning. Higher wage gains at this point in the long march to full employment in the coming months would in fact probably be unwelcomed, at least in the sense of threatening the gradual path for rate hikes most of the FOMC envisions. If anything, protecting that shallow path and avoiding the potential need to raise rates rapidly is one of the key arguments underpinning the “mid-2015” window for a first rate move. ***
The NFP Takeaways
This morning’s numbers are all good but they are nevertheless only just above the range of the Fed’s already optimistic base case path for the projected labor market gains through the year: sustained improvements in the labor market is being assumed through this year, with solid job gains steadily pulling down the headline unemployment rate, the part-time being pulled in to the full-time work force, and discouraged workers slowly being drawn back in as well.
And while much has been made of the absence in today’s jobs data again of decent wage gains, that is a positive not a negative reinforcement of the Fed forecasts, at least in terms of the presumed near-term policy path. Keep in mind that higher wage growth is the last leg of the labor market healing, and the Fed’s current projections are for it to only start showing up in a sustained way well into the second half of this year, if not the turn of the year once the headline unemployment rate is closer if not through the assumed longer run unemployment level, or NAIRU.
While the December Summary of Economic Projections put the longer run unemployment level at 5.2% to 5.5%, most but the most hawkish Federal Open Market Committee members (who it has to be said have been consistently wrong for years) are at the low end of that range, and several are nudging their estimates lower still to no more than perhaps 5% (SGH 2/18/15, “Fed: The Minutes, the Testimony, and into March”).
In other words, the great job creation numbers notwithstanding, there is still enough of an output gap and labor market slack that needs to be overcome before upward wage pressures will become more broad-based — and underpinning the upward pressure on inflation.
Protecting the Gradual Path
More than one Fed official, most recently Vice Chairman Stan Fischer, have expressed a little irritation at the attention being put on the exact timing for the long awaited rates lift-off rather than the more consequential path of rates once the tightening cycle is underway. But to be fair, the FOMC hasn’t quite reached a consensus on that most likely pace and path of rate hikes and it will be a major topic on the agenda in the upcoming March meeting.
But for the most part, the somewhat still vague messaging has been for a gradual, shallow tightening trajectory, and if anything, protecting that shallow path and avoiding the potential need to raise rates rapidly is one of the key arguments underpinning the “mid-2015” window for a first rate move.
There are at least two reasons Fed officials talk about a gradual rate trajectory. The most obvious is to avoid the need at some point for a sharp or rapid escalation of rate hikes that risks derailing the recovery or causing major dislocation in the financial markets. The echoes of 1994 ring loud down the corridors of the Fed as does the taper tantrum of 2013.
There is also a view that by stressing how gradual the trajectory will be, it may take some of the sting out of a first hike, thus dampening the market’s tendency to reprice most of a tightening cycle in an immediate response. And with an eye further down the road, there is another equally important desire to gradually and more gently restrain any upward momentum in inflation once it is moving off its currently sticky levels around 1.5%. As the Fed gets ever closer to achieving full employment, there is far less tolerance to overshoot the 2% medium term inflation target by too much or for too long (see SGH 12/11/14, “Fed: The Case for June”).
So in that sense, faster or higher wage gains at this point in the coming months would put that desired gradual path at risk, because the stronger wage gains would signal the anticipated slow momentum for the upward pressures in inflation would likewise be coming sooner and higher.
Along the same train of thought, a strong majority of the FOMC would ideally want to be moving off the Zero Lower Bound and pushing the range for the federal funds rate to or near the 1% level by the time those sustained, broad-based wage gains are finally showing up across the data.
And that, again, is pointing to the June through September window for the rates lift-off, and if anything, is likewise pushing the consensus within the FOMC back to June from the previous slippage to a more cautious September first rate hike.