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The US Bureau of Labor (sic) Statistics usually releases its Non-Farm Payroll (NFP) report on the first Friday of each month. But occasionally, like now, it’s the second Friday. So, we have to wait until the 8th July to get the latest update. Historically, the NFP is considered the most important data release of each month. It is the most extensive employment measure of the world’s biggest economy, so is considered a strong indicator of global economic health, even though it is backward-looking. It’s important to traders as it can often lead to dramatic market movements, particularly if the release is significantly outside market expectations.
Payrolls versus inflation
But we have seen a marked shift in attitude towards the Non-Farm Payroll data. This has been particularly noticeable over the last year and a half, as we move further away from the chaotic month-on-month payroll changes we saw as the pandemic took hold. The NFP release has lost its ranking as the top monthly data release. Instead, it is inflation numbers, particularly the Consumer Price Index (CPI) and Core Personal Consumption Expenditures (PCE) that now engage traders and commentators alike.
Dual mandate
The US Federal Reserve has a dual mandate. One part is to maximise employment and the other is to work to ensure financial stability. The former requires no explanation, but the latter is all about controlling inflation. The Federal Reserve has a 2% inflation target, as measured by Core Personal Consumption Expenditures. Core PCE differs from Core CPI in that it only measures goods and services targeted towards and consumed by individuals. It tends to understate inflation when compared to the CPI data. But most investors focus on CPI, even when considering the Fed’s 2% target.
Record lows
Back in 2020, as governments around the world responded to the coronavirus by locking down the global economy, the US lost over 21.5 million NFP jobs in just two months. Since then, there’s been a relatively steady increase in payrolls. While still just over a million short of making back all those lost jobs, the Unemployment Rate stands at 3.6%. That is just 0.1% above the pre-pandemic level, which was itself close to a 50-year low. For now, at least, employment isn’t the issue. Inflation is. We’re already experiencing soaring prices and a cost-of-living crisis, leading directly to a fall in demand. Consumption is estimated to account for around 70% of US economic activity when measured by GDP. Put a dent in this and companies will lay off workers. The government loses tax revenues while benefit payments rise, and the jobless cut back on spending. Corporations cut more staff, and a downward spiral takes hold within a recessionary environment.
Inflation and monetary policy
Headline year-on-year CPI stood at 1.5% in March 2020. It dropped to +0.1% in May, its lowest in just under five years, before pushing higher. By May 2021 it stood at 5.0%, well above the 2% target, as members of the US Federal Reserve insisted it was transitory and nothing to worry about. Last month it reversed a small decline to hit 8.6%, its highest level in forty years. The fear is that it has yet to peak. This has forced the US central bank to switch to an unexpectedly aggressive pace of monetary tightening. Just to give some perspective, between the beginning of 2016 and December 2018, the Federal Reserve raised rates to 2.5% from below 0.25%. By the summer of 2019 it was reversing course, cutting rates until the Fed Funds was back below 0.25% by April 2020. It began raising rates in March this year and has continued at each meeting since, taking the Fed Funds rate up to an upper limit of 1.75%. The Fed is expected to raise rates to 2.5% at its July meeting, with the terminal rate expected to be between 3.5 and 4.0%, possibly by year-end. This tightening is having a devastating impact on equity and bond prices. The S&P 500 has been in decline since the beginning of the year. And so far, every rally attempt has been met with a wave of selling. The outlook seems grim, with second quarter earnings expected to be a disaster. What could possibly stop the rot? Well, any indication that inflation has peaked, and that the Federal Reserve can ease up on raising rates. That’s why the central bank, and investors everywhere, are fixated on the release of every single scrap of inflation data. For now, Payrolls take a back seat.
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