Fra BNP
The upside surprise in non-farm payrolls gave a clear signal that the disappointing August-September employment gains were likely just a blip.
We think this significantly increases the odds of a December rate hike and have shifted our expectations for the timing of liftoff to December (previously March). In October, 271,000 jobs were added, above our and consensus expectations (150,000 and 185,000, respectively), with the unemployment rate falling 0.1pp to 5% and stronger earnings than predicted (0.4% m/m, 2.5% y/y).
Hiring was stronger than expected in the construction and education & healthcare sectors, which added 31,000 and 57,000 jobs, respectively. The largest downside surprise, relative to our forecast, came in the transportation and government sectors.
The household survey showed a 320,000 gain in employment in October, with a small increase in the participation rate (now 62.4%), which pushed the unemployment rate down to 5% (5.04% unrounded). Average hourly earnings rose 0.36% m/m, above consensus expectations, following a flat month in September; the annual rate increased 0.2pp to 2.5% y/y – its fastest pace since July 2009.
The current unemployment rate (5%) stands in line with the FOMC’s latest central tendency for the long-term unemployment rate (or non-accelerating inflation rate of unemployment) of 5.0-5.2% Without the improvement in the participation rate, the unemployment rate would have been 4.9%. The unemployment rate is now at its lowest level since February 2008 and is below the Fed’s current forecast for year-end 2015 of 5.2-5.3%.
The under-employment rate, which measures unemployed, involuntary part time, and marginally attached workers, fell to 9.8%, declining by more than the change in the unemployment rate. The chance of the Fed hiking rates in December has increased significantly enough for us to shift our baseline from March to December.
This change reflects two factors: 1) the data have been better than expected and 2) the FOMC seems to have a slightly more hawkish reaction function than we thought. We had expected a much worse payrolls number, an unchanged unemployment rate, and for earnings growth to have remained flat.
The data have been better than we expected, with payrolls bouncing back being consistent with a stabilization in activity, rather than a deceleration. Our call for the FOMC to wait until March to hike rates was contingent on more pessimistic results. Recent Fed communication indicated that the FOMC is on course to normalize rates, unless it is significantly disappointed by data or financial conditions.
Things don’t have to get better, they just can’t get significantly worse, in our view. Our previous impression was that stronger data would be needed to give the FOMC the confidence to move forward with normalization. If there are no shocks, the Fed is likely to normalize rates gradually beginning in December.
Fed Chair Janet Yellen has said that equilibrium real rates are around zero; our best guess is that ‘base camp’ for nominal fed funds rates is about 1.2-1.5%. We believe the plan will be to deliver roughly this amount of tightening over the next year to 15 months.
The biggest threats to the Fed’s normalization plans are financial, including: * a sharp appreciation of the USD * negative foreign developments that roil the markets (eg, China or Brazil) * far higher risk premia, which cause a monetary tightening in the US * much lower stock prices
