US: Payrolls Weak - but Probably Too Weak

• The US job report was even worse than feared for May. Total payrolls rose a meagre 54,000, undershooting consensus by more than 100,000. The unemployment rate rose for the second consecutive month.
• Following the euphoria after the April job report, these numbers are a reminder that we should not put too much emphasis on one set of figures. Rather, it is necessary to look at the trend. The three million average of job growth is now 160,000 - still up from the 120,000 pace early in 2011, but far from the 240,000 level in April.
• Our nominal income proxy continues to point to robust income growth, as total hours are still on a decent trend. However, there needs to be stronger payrolls in the coming months to keep this trend intact.
• The data will add to the growth scare. However, we still believe that we are witnessing a soft patch and that growth will recover again in H2. Payrolls are expected to reach an average of 200,000 in the summer. The rise in the employment index for the ISM non-manufacturing in May - also released today - underpins the fact that job creation is still intact.

Details

Non-farm payrolls rose 54,000 in May, which was much worse than feared. Although expectations had been scaled back after the ADP number, the decline in the consensus estimate from 200,000 to 165,000 was not sufficient. Our own estimate of 130,000 also proved too optimistic.

The service sector was behind most of the weakness as job gains declined to 80,000 in May from the strong level of 213,000 in April. The retail sector in particular disappointed with a decline of 9,000 following a rise of 64,000 in April. The softness in consumption recently may be hitting job growth in this sector now. The manufacturing sector also only added 3,000 jobs down from 38,000 in April. Government jobs were weak again, declining by 29,000 following a decline in April of 19,000. Hence the public sector continues to be a small drag on job creation and this will likely continue for some time as fiscal policy is tightened and local governments are making cutbacks.

The unemployment rate rose to 9.1% from 9.0% - also worse than consensus (8.9%). It mirrored a rise in the labour force of 272,000 while employment from the household survey was also soft rising only 105,000.

Average hourly earnings grew 0.3% m/m in May, higher than consensus (0.2%). But downward revisions mean that the annual rate was only 1.8% vs expectations of 1.9%. Hence wage pressures are very subdued.

On a more positive note the three-month annualised rise in nominal income rose to 5.7% in May from 5.6% in April. This is due to a still healthy rise in aggregate private hours of 3.9% on a three-month annualised basis. To keep up the pace of income growth, however, we need to see payrolls pick up again in the coming months

Today, we also received the ISM non-manufacturing index which staged a rebound following the sharp dive in April. Importantly the employment index also recovered to 54 in May from 51.9 in April. This points to service sector job growth of around 180,000 and hence much better than the 80,000 seen in today's report.

Assessment and outlook

The data is a reminder to not put too much weight on a single number but rather to look at the trend in data. Non-farm payrolls are rising on a 160,000 average, currently up from 120,000 in early 2011. While still being an improvement it is a much slower pace than the 240,000 increase seen last month. This is clearly a disappointment.

It is uncertain how much impact the distortions from the Japanese earthquake are having. But given that most of the weakness is seen in the service sector, the main reason for the softening is more likely to be the weaker consumption seen this year.

Where to go from here? We still expect non-farm payrolls to be on an improving path as productivity is stretched to the limit; any growth will need to imply hiring. However, we scale down our estimate for the trend in payrolls from 250,000 over the summer to 200,000. The slower growth seen early in 2011 is having a bigger impact on payrolls than seemed likely after last month's strong report.

The data will add to the current growth scare in the US and more people will call for QE3 from the Fed. However, we think the bar for more QE is very high this time as the inflation picture is much different, with core inflation heading for 1.5-2%. Also, the Fed will likely see this as a temporary decline in growth as most of the headwinds causing the soft patch are turning and will provide mild tailwind in the coming quarters. Oil prices are lower, Japanese production is on the rise again following a very steep decline in March and China is expected to regain some speed in H2 as well. These are also the reasons why we don't expect to see a double dip, but instead a soft patch followed by recovery in H2.