March 2023 NFP Review – Fed Likely to Hike in May

Summary

• NFP was as expected and consistent with continued strong expansion.
• Nominal wage growth accelerated but remained low, which reflects compositional effects and disinflation. 
• Real wage growth acceleration has put pressure on profits, which could signal a forthcoming inflation acceleration as businesses defend their margins.

Market Implications

• Market pricing of a 70% chance of a hike at the 3 May FOMC meeting seems about right.

Employment Growth Consistent With Strong Expansion

March nonfarm payrolls (NFP) at 236,000 aligned with expectations of 230,000. Employment growth continued to slow YoY, but remains twice as fast as before the pandemic and 1.5 times faster than labour supply (Chart 1). Unemployment fell by 10bp to 3.5%.

As I expected, the participation rate increased by 10bp, which could be related to the trough in the household savings rate. The recovery in savings, in turn, could reflect that for a growing number of Americans, the pandemic transfers have been spent. Consequently, they are returning work (Chart 2). If so, the recovery in participation has further to go.

In theory, an increase in participation is disinflationary since it increases the supply of labour and therefore moderates wage growth. In practice, the change is likely too gradual to have a discernible impact on wages. 

Low Nominal Wage Growth Reflects Disinflation

Average hourly earnings growth accelerated by 10bp to 0.3% MoM, which seems inconsistent with the tightness of the labour market.

This partly reflects compositional effects. For instance, overtime hours as a share of total hours remained low (Chart 3). Furthermore, growth in low-paid employment remains faster than growth in higher-paid work (Chart 4).

But the key factor driving the nominal wage growth slowdown is disinflation. In real terms, real median wage growth has been accelerating since early-2022 (Chart 5). 

As a result of the recovery in real wage growth, the income share of labour has been rising while that of profits has been falling (Chart 6). This creates a risk that inflation could accelerate again as businesses defend their profit margins. The risk is significant as the US economy is highly concentrated and resource pressures remain pervasive, as shown for instance by an unemployment rate at a 50-year low.

Market Consequences

Following the NFP release, the market priced a 70% risk of hike at the 3 May FOMC meeting, from previously about 30%.

This seems about right. Yesterday’s Nick Timiraos WSJ article on how the 25bp March FFR hike was decided gives us clues for the May meeting. The article stated that:  

1. The decision was very finely balanced and was made just before the meeting instead of the usual 10 days before.
2. The Fed balanced banking stability risks against inflation risks. Signs that the CS/UBS merger was digested well by markets were a key factor.

The backdrop to next month’s FOMC meeting is likely to be continued banking stability. Yesterday’s Fed balance sheet showed further stabilization as lending to banks continued to decrease. At the same time, money market fund (MMF) assets increased but less so than the previous week. Since MMF assets are tightly correlated with deposits, this is another sign of bank stability. Also, deposit flights reflect largely quantitative tightening rather than a loss of confidence in banks.

Against a backdrop of continued banking sector stability, the Fed is likely to focus on inflation risks; today’s data show these remain substantial. If the CPI comes out, per consensus, at 40bp MoM for core and banking stability continues, there is a good chance of a 25bp hike next month.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF, and the World Bank. She joined Macro Hive soon after its inception.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)