The U.S. employment report for June, which shows an increase of 147,000 jobs, is not as strong as it appears at first glance.
A softer pace of aggregate demand, driven by a decline in the three-month average annualized pace of spending to 1.6% through May from 4% at the end of last year, is the major catalyst for a more modest pace of economic activity and hiring through the first six months of the year.
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With weekly aggregate payrolls flat, tighter immigration policies and softening private sector labor demand, job growth is likely to become much slower than it has been in recent years.
Outside of a one-time, non-replicable increase of 80,000 state and local jobs in June, the labor market, like the economy, is cooling.
Private sector hiring cooled notably in June to an increase of 74,000 jobs from 137,000 as the pace of private education and health care hiring eased to a 51,000 increase from 83,000.
The decline in the unemployment rate to 4.1% was a function of a non-virtuous 130,000 decline in the size of the labor force and will be reversed over the next two months.
One gets the sense that tighter immigration policies are beginning to affect the size of the labor force and will impose a ceiling on any prospective increase in the unemployment rate as the economy slows.
No rate cut in July
The Federal Reserve will look at this data and see it as reaffirming its analysis of an economy that is slowing but still on a growth path that does not require policy accommodation given the risk of inflation.
We expect a 0.3% increase in the June consumer price index. We think that the Fed is well positioned to remain on hold until at least September if not December.
Our model of the Fed’s reaction function, updated to reflect the June employment data, implies an optimal federal funds rate of 4.65%, which is an increase from 4.55% previously and the 4.25% average in the first quarter.
That change will not bolster confidence in a near-term rate cut as central bankers shy away from pronouncements supporting such policy actions.
Inside the data
The three-month average change in hiring now stands at 150,000, which is slightly above the 130,333 six-month average for this year.
Total private hiring in June increased by 74,000 as goods-producing jobs advanced by 6,000, construction by 15,000 and manufacturing lost 7,000 positions.
Private employment in services increased by 68,000, of which 51,000 of those were in private education and health care, and 20,000 were in leisure and hospitality.
Outside of those two areas, private hiring was weak. Trade and transport added 3,000 jobs, retail trade 2,000, information 3,000 and financial services 3,000, all while professional business services contracted by 7,000 jobs and temporary hiring fell by 3,000.
Hiring by the federal government declined by 7,000 positions while state and local hiring increased by 80,000.
Average hourly earnings increased by 0.2% and were up by 3.2% on a three-month average annualized pace, which is down notably from the 4.1% gain posted in January.
Aggregate hours worked dropped by 0.3% in June and rose from 2.5% in May to 1.8% in June on a three-month average annualized basis. This trend does not bode well for the pace of spending in the second half of the year on the back of the decline in spending over the past six months.
The median duration of unemployment increased to 10.1 weeks while the level of those not in the labor force increased by 329,000 to 103.2 million, which is because of a combination of workers retiring and tighter immigration policies.
The takeaway
The slower pace of hiring in the June jobs report is consistent with the moderation in economic activity in the U.S. The headline increase of 147,000 positions, driven by the one-time increase of 80,000 in state and local hiring, partially masks the underlying weakness in private sector hiring.
In addition, the interplay of retirements and tighter immigration policies is reducing the labor supply, and that is why the unemployment rate declined to 4.1%.
This dynamic will bolster the argument of those at the Fed that it is not appropriate to reduce the federal funds policy rate at the July meeting and reduces the probability of a September cut.
Investors, in response, have reduced the probability of a July cut to 5.7%, 71.5% in September, 59% in October and 71.2% in December.
And this is sure to increase tensions between the Fed and the White House, leading to a long sizzling summer in Washington.
