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Another pending disagreement between markets and the Fed

·Senior Markets Editor
·3 min read
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This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Thursday, May 27, 2021

Bad news will be bad news in the May jobs report.

We're a little over a week out from the May jobs report.

And after April's data showed a startling miss relative to expectations — just 266,000 jobs were added back to the economy last month; Wall Street economists expected 1,000,000 jobs would be recaptured — conventional wisdom says a strong bounce in May is needed to show the economic recovery remains on track.

Total employment in the U.S. as of April was still 8.2 million below February 2020 levels, the last month before the pandemic-induced recession began. Enhanced unemployment benefits helped and continue to help millions make ends meet. More competition for labor is a positive development. But almost 10 million folks who had been working before the pandemic are not. There remains considerable repair required before we can begin discussing anything resembling "full employment."

But how the Federal Reserve and markets are likely to interpret next week's data illustrates a difference of opinion in how policymakers and investors see the recovery and economic risks.

As we outlined in yesterday's Morning Brief, the Fed believes inflation pressures caused from a near-term imbalance between demand and supply will not last.

One of those imbalances, of course, is the demand for workers who are right now in short supply.

A strong jobs number next Friday will reflect at least one bottleneck loosening and suggest the forces pushing up the price of goods and services will be transitory. Just as the Fed has been arguing.

"A payroll number which would scare the markets likely would have the opposite effect on the Fed," Pantheon Macroeconomics' Ian Shepherdson said in a note published Wednesday, "because it would indicate that labor supply is less constrained than the April employment report seemed to suggest."

In Shepherdson's view, above-consensus job gains in May might spook markets but reassure the Federal Reserve and vice versa.

The better the job gains in May, in other words, the less the Fed will feel compelled to change its stance. As of today, Shepherdson expects job gains will total 700,000 in next Friday's report, an estimate that could move by up to 300,000 in either direction.

"Most of the time," Shepherdson adds, "both markets and the Fed regard payroll growth as a proxy for labor demand, and supply considerations don't play much part in the story. The labor force is assumed to grow in line with the rate of growth of the adult population, so when payroll growth is faster than that, the unemployment rate falls and inflation forecasts duly rise. Now, though, the payroll numbers clearly are telling us something about supply too, because we know that demand is off the charts."

Job openings in March, as we highlighted earlier this month, surged to a record high, a sign that demand for workers remains robust.

But if supply constraints continue to hamper the jobs recovery and employers must keep ratcheting up wages, bonuses, and other enticement to hire workers then wage inflation could shake the Fed's confidence in keeping rates low as pricing pressures endure.

A reminder that policymakers view just about everything in this economic moment — unemployment, GDP growth, inflation, housing prices, and so on — as an aberration growing out of the pandemic. And that it will take big surprises sustained over time from economic data to start really changing this view.

By Myles Udland, reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

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