Today, the labor report for June showed nonfarm payrolls increased by 224,000, a strong rebound from the 72,000 rise in May and beating the consensus forecast of 160,000. Manufacturing payrolls rose by 17,000, better than expected given that the manufacturing sector has been showing signs of weakness.
Other data in the report was mixed. The unemployment rate ticked up to 3.7% from 3.6% in May, and average hourly earnings were a bit softer than expected, rising 3.1% year-over-year, the same as in May.
The combination of strong job growth and modest wage growth suggests that the labor market is not overheating. Higher labor force participation rates for women and those above the age of 65 have helped to boost the supply of workers, allowing for sustained job growth. However, it still appears that the underlying pace of job growth is slowing: payrolls have increased by an average of 180,000 per month so far in 2019, down from 200,000 per month in previous years.
Bond yields rose following the announcement. While the market still expects the Federal Reserve to cut rates at its next policy meeting on 31 July, the chances for a cut of more than 25 basis points now appears low.
Given that current economic and financial market conditions are reasonably strong, the fact that the Fed is even considering a rate cut is somewhat difficult to explain. In our view, after years of inflation falling short of the Fed's 2% target, the Fed is putting more emphasis on inflation in its policy decisions. Even with job growth picking up in June, the modest pace of wage growth suggests that inflation will continue to fall short of the target. Inflation expectations have also fallen to a level incompatible with the 2% target.
With the economy facing downside risks from both domestic and external forces, the Fed may cut rates even though current conditions would appear to suggest that they would stay on hold.
Key data releases before the Fed's decision on 31 July include: job openings (9 July), CPI (11 July), Fed Beige Book (17 July), 2Q19 GDP (26 July), and the Employment Cost Index for 2Q19 (31 July).
Brian Rose, Senior Economist Americas, UBS Financial Services Inc. (UBS FS)