Since the 16-17 September Federal Open Market Committee (FOMC) meeting, Committee participants have made a concerted effort to communicate their confidence in the US economic outlook and expectations for a start to policy normalisation by the end of this year. This effort stems from the Committee’s concern that many market participants interpreted the September meeting communications in an overly pessimistic light and pushed their expectations for lift-off into 2016. If post-meeting communications have been notable for their coordination and consistency, they have been even more remarkable for their lack of effect on market expectations. Even before the publication of the disappointing payrolls report on Friday 2 October 2015, the market-implied probability of a federal funds rate increase by the end of the year had drifted lower, despite Chair Yellen’s 24 September speech in which she made clear her own expectations for lift-off to begin later this year.
The recent divergence between market expectations and Federal Reserve communications has its roots in two related factors, namely, core inflation that remains stubbornly below the Committee’s 2% objective, and a weakening global growth outlook that has contributed to tighter financial conditions and weighed on both sides of the Federal Reserve’s dual mandate. Now, following the September employment report, a third factor—slowing momentum in the labour market—has only increased the wedge between market expectations for policy and those of most Committee members. Both the establishment and household surveys were generally weak, with the former revealing that monthly jobs growth has averaged under 150 000 over the past two months, down from a monthly pace above 200 000 jobs in the first half of the year.
What is striking about the recent slowdown in the pace of jobs growth is that it is not just in the goods-producing sectors affected by US dollar appreciation and low commodity prices. More recently, job growth has slowed in the services sector as well (see exhibit 1 below). Some of this slowing in the pace of jobs growth—for example in trade services, transportation and warehousing—may reflect second-order impacts of a tougher environment for exports and commodity-related sectors. But a slower pace of jobs growth in other sectors less tied to the global environment may point to a broader, if modest, slowing of momentum in the labour market. In a sense, this should not be surprising; recent data indicate that third-quarter GDP will likely come in below 2%. The key question is whether growth will rebound to a pace sufficiently above trend to sustain payrolls growth above 200 000 jobs per month. If not, a more lasting step-down in the pace of payrolls growth to around 150 000 jobs per month could become the norm.
Exhibit 1: Change in private non-farm payrolls by sector - job creation is slowing in both the goods-producing sectors and the service sectors of the US economy.
Source: Bloomberg, as of 2 October 2015
The employment report did include some bright spots. The broader U6 measure of the unemployment rate, which includes discouraged, marginally attached and part-time workers for economic reasons, continued its steady march downwards. And jobs growth in the leisure and hospitality sectors has remained strong, likely reflecting healthy consumer confidence. However, it is an open question if this trend will continue, as announced corporate layoffs have recently increased to levels not seen in several years (see exhibit 2 below). This could portend some slowing of job growth in service sectors highly sensitive to consumer sentiment.
Exhibit 2: The Challenger job-cut report is released monthly and provides information on corporate layoffs in the United States - the graph below shows the 3-month average of job-cut announcements by US corporates for the period from 1999 through September 2015
Source: Bloomberg, as of 2 October 2015
A number of Committee members described the decision not to raise rates at the September meeting as a “close call”, and presumably the same calculus would have applied at the meeting later in October. But last week’s employment report effectively kills the prospects for policy normalisation to begin in October. To use a baseball analogy, the economy is now batting 0 for 3 on the conditions for lift-off: financial conditions have not yet shown clear signs of stabilising after tightening in recent months; base effects are not likely to boost inflation readings until later this year; and the slower pace of jobs growth, should it continue, implies slower progress in eating through the remaining labour market slack and less confidence in the inflation outlook.