US Dollar Weighed by Surprise Miss in Payrolls but Wage Numbers Limit the Damage

The U.S. workforce grew at a slower-than-forecast rate in December but we note damage to the Dollar is likely to be limited in nature.

Data from the Bureau of Labour Statistics showed on Friday, Februrary 5 that new jobs in the U.S. rose 148k in December compared to the 252k recorded in November. Markets were pricing in a reading of 190k which explains a drop in the value of the Greenback.

The weaker result for December can be traced to the service sector in which retail employment fell by 20,000 jobs as the industry continues to adjust to changing buying patterns both on a seasonal and long-term basis.

The November data were revised up from the original 228k result while the unemployment rate remained stable at 4.1% in line with expectations. 2017 was the seventh straight year, in which the US economy created more than two million new jobs.

The Dollar weakened initially, falling to GBP/USD 1.3582 and EUR/USD 1.2082, however, it recovered in the first 15mins after the release, to 1.3555 and 1.2059 respectively.

"Both US Treasury yields and the dollar have fallen in the immediate wake of the report. However, we would say that this report makes little difference to the outlook for US interest rates," says a note from Lloyds Bank Commercial Banking in response to the release.

Indeed, damage to the Dollar was softened on additional data showing average hourly earnings - which some see as more important to the Dollar due to its direct implications for inflation - advanced 0.3% month-on-month in December, in line with forecasts and compared to the prior 0.1% increase which was revised down from an initial 0.2% advance

Looking ahead, analysts are expecting the pace of jobs growth to fade following seven years of impressive growth.

"The streak is likely to end here, as payroll gains have been gradually but consistently slowing since 2014 with the economy approaching full employment," says Dr. Harm Bandholz, Chief US Economist with UniCredit Bank in New York.

John E. Silvia, Chief Economist with Wells Fargo says it is clear to him that structural issues persist. For example, "while the labour force participation for men is higher than for women, growth in the prime age participation rate has only been experienced by women.

"These growth dynamics, or lack thereof, will pose a challenge to achieving sustained 3 percent growth," says Silvia.

Analyst's Reactions:

Francis Généreux, Senior Economist, at Desjardin Credit Union in Paris.

"Job creation returned closer to its long-term trend in December, and we cannot consider this slowdown as a sign of weakness."

"It is also not unusual at this stage of the economic cycle to see slightly lower annual gains. Nevertheless, the Federal Reserve, which will soon be led by Jerome Powell, will likely raise its key interest rates at its March meeting."

Dr. Harm Bandholdtz, US Economist, at Unicredit in London:

"The dynamics stayed strong enough to put further downward pressure on the jobless rate, and we continue to see it falling to 3½% by the end of this year. And while wage gains have remained muted, this leaves the Fed on track for further gradual rate hikes."

"Despite this heavily diminished labor market slack, wage gains have remained muted. While average hourly earnings were up a solid 0.3% mom in December, the November gain was revised down to 0.1% from 0.2%. As a result, the yoy rate came in at a moderate 2.5%."

David Lamb, Head of Dealing, at Fexco Corporate Payments:

"The Dollar’s new year blues just got bluer.

“Ironically it wasn’t the weak headline figure in this latest jobs report that sent the Greenback skidding – but rather the insipid levels of wage growth."

“The Dollar has been on the back foot since the Fed’s half-hearted interest rate hike in December, and the confirmation that the average American’s paypacket continues to stagnate has hit Dollar confidence again.

“Underlying it all is the sense that the Fed may hold off on committing to multiple rate rises in 2018."

Waning Significance for the Dollar?

Of most importance from a currency perspective is how the data impacts on the Federal Reserve's decision-making in setting interest rates as these are a major driver of the Dollar.

Typically when the data is positive then there is a higher chance the Fed will raise interest rates and the Dollar will rise, because higher interest rates are supportive of currencies due to their draw on investors seeking somewhere to park their capital where they are likely to get a good trade-off between return (interest) and safety.

If on the other hand it results in a Fed more likely to cut rates then the opposite happens and the Dollar declines.

In the period after the financial crisis the Dollar used to rise sharply when the NFP headline figure was high as it indicated more people were getting jobs which would probably lead to higher inflation eventually, as a) they would have more disposable income, and b) a tightening labour market tends to result in higher wages as workers gain leverage when there are less potential replacements available to fill their role.

The relationship between levels of employment and wages has a name in economics, it is called the Philips Curve.

In reality, however, higher employment has not in fact lifted wages or inflation as much as had been expected, and economists are now questioning the validity of the Philips curve as a tool for forecasting inflation.

This explains why the Dollar does not rise as much as it used to when NFP's are positive - because there is no guarantee wages will rise.

Recently the market has focused more on the actual wage component of the NFP report to seek confirmation of higher inflation pressures.

As can be seen from the chart below earnings growth has been pretty uniform since the initial recovery following the financial crisis - but it has not accelerated as would have been expected given unemployment has fallen from 10.0% to 4.1% over the same period.

Even wages on a monthly basis appear to show a great deal of volatility as shown in the chart below - especially in the most recent data.

The point is highlighted by Lloyds Bank's Cross Asset-Strategist Robin Wilkins:

"Wage growth has been a key factor for policy makers. The risk is it remains modest. November saw a monthly rise of only 0.2%, which left annual growth at only 2.5%. We forecast a 0.3% increase, which, if realised, would leave the annual rate unchanged," he says of this afternoons figures.

Wilkins is confident in the operation of the Philips Curve at some level, for he expects wages to eventually pick up.

"We do expect the increasingly tight labour market to lead to an acceleration in wage growth this year. Indication that this is happening will be one of the key factors in determining the pace of Fed rate hikes this year," says the Lloyds strategist.

Viraj Patel, an analyst with ING Bank N.V. in London notes that favourable data has had less and less of an impact on the Dollar in recent times, which is negative indication.

"We note that the dollar has de-coupled from positive US data surprises in recent months– an added sign that it has lost its status as an investment currency, with negative structural factors and political risks playing a greater driving role."

This echoes recent comments from other Dollar-bearish analysts in relation to the currency's lack of sensitivity to interest rate news.

Both Deutsche Bank's George Saravelos and BMO's Stephen Gallo have suggested recently that the Dollar will become increasing insensitive to further rises in interest rates as the most upside comes at the start of the hiking cycle, with rapidly diminishing returns after three hikes.