US: The payroll report was solid, but what will Janet think – RBC CM

Research Team at RBC Capital Markets, notes that the Fed hawk and recent dissenter Loretta Mester called the payroll report “solid” and said she thinks we are at full employment.

Key Quotes

“We agree with her characterization of the report and her assessment about full employment. But as we have been writing about with great regularity, it matters not what we or the hawks think about the backdrop. Yellen and the doves remain in control of the narrative as it relates to the fate of Fed funds and they may view this report as somewhat lukewarm. Try as they might to pitch that idea, most of the key metrics do not support that narrative.

Most critically for the fundamental backdrop, aggregate wages advanced a nice +0.7% m/m in September after sinking -0.1% last month (that was the worst read since February, when global markets were in an upheaval). The y/y rate rose to 4.3% from 3.5% and the average for Q3 shakes out around 4%. When you strip out headline inflation near 1%, it leaves you with real consumer incomes at a very healthy 3% clip (which supports a robust consumer spending backdrop and, commensurately, topline GDP).

Participation ticked up to a 6-month high of 62.9% from 62.8% as the labor force expanded by a significant 444k. But the reason the unemployment rate barely ticked up (it went from 4.92% to 4.96% unrounded) is because nearly 80% of that labor force increase fell into the “employed” column—which jumped 354k in the Household Survey.

Further beneath the surface, the participation number that really caught our eye is the one for “prime age” workers. The 25-54 year-old cohort saw labor force participation jump to 81.5% from 81.3%, which is the best read since October 2012 and reflects an important retracement higher in this “cyclical” indicator.

In other words, beneath the surface there was a lot to like in this report. Nevertheless, we have to remember Yellen’s rationale for not raising rates in September, to wit: “…but with labor market slack being taken up at a somewhat slower pace than in previous years, scope for some further improvement in the labor market remaining, and inflation continuing to run below our 2 percent target, we chose to wait for further evidence of continued progress toward our objectives.” In other words, she wants to see the unemployment rate improve. And it didn’t. On that point alone, this report would continue to justify a stand-pat stance.

But here is the rub – and something that continues to be overlooked by a number of folks. While Yellen expressed disappointment that the u-rate hasn’t improved over the last year, in her very next breath she said, “I don't see that as bad news because it may reflect that the strong labor market is attracting people perfect from outside the labor force back into employment.” That’s pretty much what happened today.

As we said at the top, Yellen remains in control of the fate of the next hike, if she really does believe a steady or even slightly rising unemployment rate could actually represent a positive dynamic then she has to emphasize that part of her narrative. Anything short of that, then let the slow bleed of current lofty December odds of a hike commence.”