Eyeing payrolls progress

The Federal Reserve wants to see “substantial progress” in the economy before it makes any move towards removing accommodation. They haven't specifically defined what that is, but they'll know it when they see it.

But if Fed Chairman Jerome Powell has used his press conferences for anything, it's to hammer home the point that he's still very concerned about the labor market, one-half of the Fed's dual mandate. “I'd say we have some ground to cover on the labor market side,” Powell said after July's decision dropped. “I think we're some ways away from having had substantial further progress toward the maximum employment goal.”

The July employment report arrives today at 8:30 a.m. ET, with economists, on average, looking for nonfarm payrolls to rise by 870K, compared with 850K in June. The jobless rate is seen dropping to 5.7% from 5.9%.

A very strong payrolls gain could lead to the Fed hinting at tapering as early as the Jackson Hole symposium this month, Jennifer Lee, senior economist at BMO says, although she is looking for a below-consensus gain of 775K. “As long as we continue to see over 500K or 600K every month, steady gains, cutting away at those losses... that to me would be 'steady progress,'” Lee said on Bloomberg.

Anybody's guess: Looking more closely at payrolls expectations, it's clear that once again Wall Street is all over the map. Forecasts range from up 350K to up 1.6M, according to Reuters.

Data points this week have been mixed. Jobless claims, while not part of the survey period, are trending in a direction that points to an improving labor market, falling to 385K, but ADP's measure of private sector payrolls came in at a relatively anemic 330K, less than half of what was expected.

In the more bearish camp, BofA Securities is looking for a 750K rise in payrolls, which it says reflects the “relatively softer high frequency data.” “Since the July employment week, the Homebase data continue to suggest labor market conditions are softening,” BofA economist Stephen Juneau writes in a note. ”Indeed, the employees working index averaged -16.3% during the week ending August 1, nearly 1.8% below the prior week’s reading.”

“It’s likely this gets revised up but it appears that small business employment growth is slowing despite more and more states opting out of unemployment benefits and overall robust demand,” Juneau says.

“The end of the month, UKG (Ultimate Kronos Group) data suggest that shift work employment actually declined in July,” he adds. “Indeed, the series shows a 0.6% drop from June. We think this drop could be partially seasonal as it may reflect summer production slowdowns.” “Additionally, UKG found that the decision of states to opt out of unemployment insurance benefits did not yield faster employment growth in an analysis of their data. This is consistent with what we’ve seen in the claims data.”

Jefferies Chief Economist Aneta Markowska is much more bullish, calling for a rise in payrolls “well above” 1M and closer to 1.5M, citing expiring UI benefits and seasonal factors. “Aggregating claims based on program expiration dates shows that the most meaningful declines occurred in the second and third weeks after the last enhanced UI payments,” she writes in a note. “This implies a sizable NFP increase in July and even larger gains in Sep/Oct.”

Will substantial progress stymie stocks? All things being equal, recovery in the labor market toward pre-pandemic levels should be bullish for equities, further boosting the potential for earnings growth. But with the historic amount of Fed easing involved, the stock market could be back to a good-news-is-bad-news scenario.

“A stronger than expected number is likely to encourage additional members of the Committee to make a hawkish pivot, raising the chances of a taper sooner than the market expects,” Caxton senior analyst Michael Brown writes. “As such, good news on the economy is likely to be bad news for risk assets in the aftermath of the report.”

Fed speakers this week have floated the idea that the FOMC could be ready to start tapering in September. “There's no reason you'd want to go slow on the tapering to prolong this. You want to get it done and get it over with,” Fed Governor Christopher Waller says. Tapering would likely push Treasury yields higher, removing a key reason for the path of least resistance for stocks still being up and to the right, even at record levels.

This week, Citi downgraded U.S. equities to Neutral, calling for the 10-year Treasury yield (NYSEARCA:TBT) (NASDAQ:TLT) to rise to 2%, with a 70 basis-point rise in real yields, which are now at record lows. Global equity strategist Robert Buckland writes that Citi's rate strategists “attribute much of the move to technical factors. Most notably, U.S. treasury issuance has dropped over the summer, but will rise again later in the year. They think that this, along with ongoing economic recovery and likely QE tapering, will push 10-year bond yields back towards 2.0%.”

Goldman Sachs just boosted its 2021 target for the S&P 500 (SP500) (NYSEARCA:SPY) to 4,700 from 4,300 in part due to the lower-than-expected rates. But strategist David Kostin says that rates above 1.6% would cut fair value back down to 4,350, below current levels. (2 comments)