Why is high interest rate still unable to suppress employment? Will the Federal Reserve take tough measures? It all depends on tonight's non-farm payroll report.

The United States employment data has once again exceeded expectations, with a significant deviation from the forecast.

According to the latest "mini non-farm" ADP report released on Thursday, the number of new jobs added in the United States in June was 497,000, more than double the market expectation of 225,000, far surpassing the previous value of 278,000, and achieving the highest monthly growth rate since July 2022.

This data highlights the continued strength of the labor market and has ignited expectations of aggressive interest rate hikes, leading to a "double kill" in stocks and bonds in the overnight U.S. stock market.

Why did ADP significantly exceed expectations? Why are high interest rates not cooling down employment? Is tonight's non-farm data a surprise or a shock?

Why did ADP significantly exceed expectations?

Analysts point out that there are three possible reasons for ADP's significant outperformance: a slowdown in layoffs in June, the phenomenon of labor hoarding, or the previous employment slowdown was just an "interlude."

1. Decline in layoffs in June

In the past few months, the U.S. technology industry has experienced a wave of large-scale layoffs, but now this trend is slowing down.

According to data released by recruitment firm Challenger, Gray & Christmas on Thursday morning, U.S. employers announced 40,709 layoffs in June, the lowest monthly figure since October 2022.

Nevertheless, the total number of layoffs announced in the first half of this year, 458,209, is still the highest for January to June since 2009, excluding 2020 when 896,675 layoffs were announced, with the technology industry accounting for the majority of the layoffs.

Andy Challenger, Senior Vice President of Challenger, Gray & Christmas, said in a statement:

The decline in the number of layoffs is not uncommon for the summer months. In fact, June is historically the slowest month for layoffs. It is also possible that the deep unemployment predicted by inflation and interest rates will not occur, especially with the Federal Reserve pausing its rate hikes.

2. Is the increase in the unemployment rate an "unexpected twist"?

The unemployment rate in the United States surged from 3.4% to 3.7% in May. The sudden and sharp increase in the unemployment rate was largely unexpected, especially considering the strong job growth.

The monthly non-farm report consists of two surveys to measure employment levels and activity: one surveys businesses on employment, hours worked, and income; the other surveys households to obtain labor force and demographic details. The unemployment rate comes from the latter survey and is considered unstable due to its smaller sample size.

Glassdoor's Chief Economist Aaron Terrazas stated in a recent comment:

With recent college graduates entering the job market and the slowing reemployment of recently laid-off workers, the unemployment rate in June may rise to 3.9%.

3. Labor Hoarding and Soft Landing

Recent labor market data shows that despite weak demand, more companies are hoarding labor and maintaining their workforce. Part of the reason for this situation is the severe worker shortage experienced during the pandemic and broader demographic changes such as the retirement of the baby boomer generation from the labor market.

Sarah House, Senior Economist at Wells Fargo, pointed out:

Given this, we do believe that businesses will be less willing to let workers go, which helps support the argument for a soft landing in the economy, reducing inflation without significant job losses or triggering an economic downturn.

Why Can't High Interest Rates Suppress Employment?

Why haven't the most aggressive interest rate hikes since the 1980s successfully lowered the inflation rate to the 2% target and cooled down the job market?

The answer is that high interest rates may not have hit the pain points of inflation. Tomas Dvorak, an economist at the Oxford Economics Research Institute, believes that the impact of interest rate hikes is only partially concentrated in sectors that drive core inflation.

It is well known that rate setters have little control over cooling commodity prices, which have been the main driver of inflation, making it difficult for the Federal Reserve to control economic activities influenced by global pricing, such as agriculture and utilities.

On the contrary, Dvorak's estimate shows that the manufacturing sector is most affected. At the peak of monetary policy impact, for every one percentage point increase in interest rates, manufacturing output decreases by 0.23%. However, manufacturing employment has already cooled down. On the other hand, service industries such as the hotel industry experience faster price increases because the impact of interest rates is not as evident.

Some economists believe that a major problem lies in the significant shift towards the service sector in the Western economy over the past 40 years, rendering monetary policy less effective. According to traditional theory, durable goods producers such as automobile manufacturers, driven by their motivation to hold large inventories, are particularly sensitive to higher interest rates.

The Federal Reserve has acknowledged that it may take longer to control inflation in the service sector. As an alternative explanation for sticky inflation, Federal Reserve research suggests that it takes 18 to 24 months for policy to have an impact across the entire economy. But if this is true, the Federal Reserve should not base its decisions on the latest inflation figures, as hawkish officials have recently indicated that the lag period has shortened.

Will Nonfarm Payrolls Face Another Shock Tonight?

The hiring activity of U.S. companies in June experienced a massive and unexpected surge, and tonight's highly anticipated nonfarm payroll report may also reflect the continued strength of the labor market.

Analysts expect that the nonfarm payrolls will almost certainly show job growth in the U.S. labor market for the 30th consecutive month. Although the current job growth has been lackluster compared to the labor market expansion from 2010 to 2019, which saw a record-breaking 100 months of job growth, the current continuous growth has exceeded expectations. This above-average growth has occurred despite a slowdown in inflation and significant interest rate hikes by the Federal Reserve.

According to data from the Bureau of Labor Statistics, there have been 1.57 million new jobs added so far this year, making it the tenth-highest figure for the period from January to May since 1939. The average monthly increase of 314,000 jobs this year far surpasses the pre-pandemic levels.

However, some economists believe that labor market growth will eventually slow down; it's just a matter of time. Economists predict that non-farm payrolls in June will be lower than this average level and lower than the 339,000 jobs added in May. According to Reuters, economists generally expect an addition of 225,000 jobs. However, there is a wide range of forecasts among the 82 economists surveyed, ranging from 110,000 to 288,000 jobs. The unemployment rate is expected to decrease from 3.7% to 3.6%, with estimates ranging from 3.4% to 3.8%.