The US employment report was a slight disappointment on the surface, not least against fairly upbeat market expectations, but it is actually quite a strong report.
First, although non-farm payrolls only rose 214k versus consensus of 235k (DBM 240k), net revisions were +31k. So including this, payrolls were actually 10k stronger than expected.
Second, the unemployment rate fell to 5.8% but was expected to be unchanged at 5.9%, since it already showed a big decline from August to September. So the decline in the unemployment rate has accelerated recently.
Third, the decline in unemployment was the result of very strong employment gains of 683k in the household survey. The labour force increased by 416k, pushing up the participation rate to 62.8% from 62.7%.
Fourth, the U6 underemployment rate, which the Fed looks closely at as a measure of slack, fell 0.3 percentage points from 11.8% to 11.5%.
The main soft spot continues to be wages. Hourly earnings rose only 0.1% m/m in the private sector (consensus 0.2% m/m) after a flat reading in September.
The annual rate was unchanged at 2.0%. There is one caveat here, though. Productivity growth has also fallen in the past years, most likely as a consequence of the low investment level in US companies. The annual productivity growth is currently running around 1% versus an average since 1990 of 2.1%. When corrected for this, labour cost pressures are higher than what meets the eye in the hourly earnings number. Unit labour costs published yesterday showed an increase of 2.5% y/y (average since 1990 is 1.4%).
All in all, the report shows that the labour market is tightening faster than the Fed expected. The unemployment rate is on track to hit the Fed’s long-term estimate of 5.4% already in early spring next year. The Fed’s projection for unemployment as recently as September was to be at 6.0% at the end of this year and 5.5% at the end of 2015. Our models suggest that payroll growth could pick up to slightly above 250k. This would likely have to come from service employment, which is currently running a bit below expectations relative to what surveys point to.
While we still look for the first rate hike in June next year, the risk is skewed towards an earlier hike. The market is pricing too few hikes in our view, as the first hike is priced in October/November and the end-15 rate is priced at 0.6% versus the Fed projection of 1.375%.
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