Janet Yellen’s Message: Last Friday’s Employment Report Didn’t Change Much

Last Friday the markets were expecting to see May payrolls rise by something between 160,000 and 190,000 new jobs. Instead the report was an upsetting shocker with only 38,000 new jobs and a downward revision to the previous two months.  Stocks sold off at the opening, gold rose, talk of a fading expansion resumed and everyone agreed that there wouldn’t be a Fed rate hike this month.  Until Friday morning Fed watchers were expecting a last minute confirmation of a June rate hike from Janet Yellen in today’s speech.  After the bad news employment report analysts feared the weakness would limit the Fed’s ability to move rates higher until later in the year.

Speaking in Philadelphia today, Fed Chair Janet Yellen was clear that one nasty employment report doesn’t change the world or the economic outlook: “So the overall labor market situation has been quite positive. In that context this past Friday’s labor market report was disappointing.”  The Fed is making progress in meeting its mandate of 2% inflation and full employment:

  • Inflation is expected to move to 2% over the next couple of years. The sharp drop in oil prices and the strengthening of the dollar which were holding inflation down are reversing and these downward forces on prices are dissipating.
  • Friday’s report notwithstanding, the job market has improved throughout seven years of expansion. The unemployment rate has fallen, the job openings rate was a record high in March and the quit rate moved up. Weekly initial unemployment claims continue at very low levels.

Yellen’s economic outlook remains cautiously optimistic, even though there are a few clouds on the horizon but further progress is expected.

  • Further improvements in the labor markets and moderate GDP growth are foreseen. Rising equity and home prices have helped restore households’ wealth and the housing sector should see further gains. Housing is supported by low mortgage rates and consumer spending is helped by low gasoline prices.
  • “On the other hand” there are some less positive issues: China’s slowing growth, falling commodity prices and weak business fixed investment in the U.S.

There are four important uncertainties that could affect the economy and monetary policy:

  • The US expansion has been largely supported by domestic demand. The question is whether US moderate growth can continue without support from other economies, especially with the weak domestic investment performance.
  • Risks outside the US require attention as well. China’s growth is a concern although their currency has moved in a more predictable fashion recently. In the current environment of low interest rates and weak growth investors’ perception of risks can change quickly.  One unknown risk factor is the possibility that Britain will vote to leave the European Union.
  • US productivity has performed poorly in recent quarters and has not shown any signs of returning to stronger growth so far. This contributes to sluggish GDP growth and poor wage increases.
  • The inflation outlook is uncertain and dependent on expectations of future inflation. While oil prices are likely to recover and the labor market is improving, there are signs that expectations of future inflation are falling somewhat.

In the face of these uncertainties, Janet Yellen remains cautiously optimistic, describes monetary policy as stimulative with the Fed funds rate below its neutral level. Given all this, Yellen expects “further gradual increases in the federal funds rate will probably be appropriate to best promote the FOMC’s goals of maximum employment and price stability.”

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