Fed: The NFP and the Reaction Function

Published on June 1, 2018

President Trump’s enthusiastic anticipation of this morning’s jobs report no doubt raised a few eyebrows, but for Federal Reserve officials, the bigger surprise was the across the board strength in today’s Non-Farm Payroll.

*** To cut to the chase, despite the strength in the jobs print, and what it may portend for a potential upward drift in the 2018 rate dots, we still think, on balance, the June median will remain at three, or if not, a fourth hike in the median is likely to be downplayed in the post-meeting presser. A June rate hike is all but certain, but we still think some running room in delaying the signaling to a more hawkish rate path is desired, ideally, until the September meeting (SGH 5/22/18, “Fed: A Honeymoon’s Second Doubts”). ***

Still (Roughly) Balanced Pressures

As Fed staff will soon be getting underway in their forecasting preparations for the Federal Open Market Committee’s June 20-21 meeting, here are a few comments on how we see the likely impact of the NFP on the Fed’s reaction function:

** On the one hand, it would be hard not to be penciling in a slightly quicker decline in the headline unemployment rate this year. The decline in the participation rate to 62.7% from 62.8%, while small, was perhaps the most noteworthy takeaway from this morning, as it suggests the fairly stable unemployment rate with new entrants absorbing the demand for workers is coming to an end.

** And for the Fed’s slack-based forecasting models, an unemployment running a full point below estimates of its longer run levels is likely to raise anxieties, even among the more dovishly inclined Committee members. It may also, in turn, encourage some upward drift in the June rate dot projections, raising the probability for that elusive fourth rate hike in the 2018 dot plot.

** But while the jobs report was probably a bit stronger than expected, the key average hourly earnings print was only moderately higher, and inflation, reflected in Wednesday’s 1.8% core PCE, is still seen as largely inertial. That may be taken to reward patience in waiting to see whether firming underlying trend inflation is breaching the 2% symmetrical inflation target with momentum.

** And offsetting the upside risks is a “roughly balanced” overhang of uncertain downside risks: elevated threats of trade tariffs and retaliation, or a wider European spillover from Italy’s travails, however low the probability, looms large, while Fed officials will also weigh dangers to the Emerging Markets or a prematurely dampened US growth due to a dollar rising too high too quickly or yields spiking over the summer if a “too soon” more hawkish rate path is signaled.

Language Tweak on June Table

** Although the June meeting is still two weeks away, there may still be some positioning by FOMC members before the pre-meeting black out sets in. In particular, we will be watching for any further views on whether the short run R* is still expected to be rising in the near term, and especially for any affirmation of greater caution on rates once at or nearing neutral.

** One compromise to get a policy consensus in June that might be on the table would be to couple the near certain rate hike to changes in the statement language; in particular, a tweak to modify the “accommodation” sentence could indicate the FOMC believes they may be nearing neutral sooner than previously believed.

** As we believe the currently solid Committee consensus for the gradual rates normalization path begins to fray beyond the near certain June rate move and certainly with a third in total rate move this year, bringing forward a two-step messaging tweak to the accommodation language to June could prove its value in ensuring a “dovish” lean to the rate hike despite a strong NFP and the possibility of that fourth rate hike making its way into the rate dot median.

Back to list