Freakishly Small May Payrolls Gain Complicates Forecasts for June

Depending on how much May is revised, there's a greater chance of an upside surprise in the June data. And that could unsettle the markets.
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For the June edition of the

employment report

, the alpha male of economic indicators, forecasters expect a payrolls number that won't shake up the 12-month average. But there's a problem: The May figure was sharply lower than that trendline. So depending on how much the May numbers are revised, there's a larger-than-normal chance of an upside surprise in the June report that could unsettle the markets.

The employment report has four main components, and here's what economists surveyed by


expect each of them to do, on average:

nonfarm payrolls

to grow by 220,000 (individual forecasts range from about 175,000 to about 275,000); the

unemployment rate

to hold steady at 4.2%, a 29-year low;

average hourly earnings

to rise 0.3%; and the

average workweek

to hold steady at 34.5 hours.

All of the forecasts are in line with recent trends. Nonfarm payrolls growth has averaged 236,000 a month over the last 12 months, and average hourly earnings were up 3.6% year-on-year in May. But the broader trend is deceleration. The 12-month average of nonfarm payrolls growth peaked at 307,000 in January 1998, and the year-on-year pace of average hourly earnings growth topped out at 4.4% in April 1998. And that's the trend economists expect to continue.

The risk of a much stronger-than-expected payrolls figure is intertwined with the

Labor Department's

seasonal adjustment process for these numbers. The May

employment report counted just 11,000 new jobs, which economists attributed to a faulty seasonal adjustment process. Accordingly, they expect an upward revision to the May number in the June report. But they also expect a payback effect in June. Depending on how the numbers are distributed between May and June, the June payrolls count could deliver a big upside surprise.

While it's the underlying trends the


will be looking at when it sits down to decide whether additional interest-rate hikes are warranted later this year, the June numbers, taken together with the revisions to May's, will reveal the extent to which those trends are continuing.

"Employment growth has slowed,"

Merrill Lynch

senior economist Stan Shipley said. "The question is, has it slowed enough to keep the jobless rate unchanged at 4.2%? Because the Fed doesn't want that rate to fall much further."


announcing its decision to drop its official bias in favor of additional interest-rate hikes, the Fed said that while it was content to have "no predilection about near-term policy action," it nonetheless recognized "that in the current dynamic environment it must be especially alert to the emergence, or potential emergence, of inflationary forces that could undermine economic growth."

The Fed arguably got a couple of warnings this morning from the June

report from the

National Association of Purchasing Management

. Its monthly report on the state of manufacturing showed prices paid by manufacturers continuing to climb and supplier deliveries slowing for the second month in a row. The bond market took a big hit on the news.

Within the payrolls number, analysts will look closely at the manufacturing component, to see whether losses in that department have finally stopped. Manufacturing payrolls have contracted in 13 of the last 14 months, including the last nine. But with the employment component of the NAPM report having shown growth for the second month in a row this morning, some are forecasting an end to that trend in June.

A rebound in manufacturing payrolls should push up average hourly earnings, since manufacturing jobs pay more than average. But that isn't necessarily inflationary,


chief economist Ken Mayland says, because U.S. manufacturers are using a smaller percentage of their capacity than they have in years (80.5% as of May), and the same is true in the rest of the world.

Recent data on housing suggest that jobs growth overall will continue to moderate, Mayland says. Both

housing starts


new home sales

have retreated from their winter peaks as long-term interest rates have risen. Housing is at the economy's leading edge, meaning that the slowing effect of higher interest rates will eventually spread to car sales and maybe even, he says, to the stock market.