Jobs report stronger than expected in June. What happens next?

The economy added 195,000 jobs in June, a strong showing that beat analysts' expectations. Steady job growth is good news, but it means that higher interest rates and an easing of Federal Reserve bond buying could come sooner rather than later, putting investors on edge. 

Wall Street has been waiting for the June jobs report with particular interest, with federal actions and investor sentiment riding on how the labor market performs over the next few months. This time around, the news is a hopeful if tempered indicator of slow, steady growth.

The US economy added 195,000 jobs in June, and the unemployment rate remained unchanged at 7.6 percent. That was notably better than predicted: Analysts had expected about 165,000 jobs added. Additionally, the job totals for April and May were revised upward, by about 70,000 jobs combined.

“The June employment report showed solid job growth…The gain in nonfarm payrolls was much larger than we and [the] consensus were expecting,” Barclays Research economist Michael Gapen wrote in an e-mailed analysis.  “Although the unemployment rate did not move lower, we see this report as signaling that labor markets are improving.”

At the beginning of the year, analysts worried that the sweeping federal budget cuts known as the “sequester” would cause economic growth to falter. for the most part, that hasn’t happened. At least not yet.

“I would have expected that the fiscal headwinds would be doing a bit more damage, and expected 150,000 to 125,000 per month [in jobs added], ” Moody’s economist Mark Zandi said in a Wednesday conference call.“ We have seen some slowing in GDP, but the economy has been navigating it quite gracefully.”

Mr. Zandi points out that the fiscal drag expected as a result of the sequester may have been offset by better than expected gains in other areas. The stock market rallied to record highs in the first part of the year, “giving business executives a reason to hang tough,” and avoid layoffs.  House prices have surged.  Oil and gas prices have fallen, benefitting lower and middle income households and likely offsetting the ill effects of the expiration of payroll tax cut.

“All of those things came together,” he says. And, “If there’s no change in policy, the fiscal headwinds will start to fade in the end of the year.”

Analysts expect that if the labor market holds steady and job creation continues at the current rate, the unemployment rate will dip below 7 percent sometime in mid- 2014. That number is key, because the Federal Reserve will allow long-term interest rates to rise once it's reached.

“Stronger payrolls mean higher long-term interest rates for the economy,” IHS Global Insight economist Paul Edelstein writes in an e-mailed analysis. “Indeed, 10-year Treasury rates surged 18 basis points to 2.69% following the report. Strong payrolls should boost market expectations for economic growth and inflation, which can push up bond yields. “

In the shorter, term, there is much speculation over whether or not the Fed will scale back its bond purchases by the end of the summer. Many economists, including Mr. Gapen at Barclays, expect the Fed to taper its purchases in September, and “conclude its purchases in March of next year.”

But others argue that the economic growth may prove softer than it looks right now, which could delay tapering. “Much is going to depend on the data flow over coming months, and we continue to believe that the economy’s momentum will prove to be less than forecast by the Fed and hence that tapering will not occur as soon as the market is anticipating,”  MFR, Inc. economist Joshua Shapiro writes via e-mailed analysis. “With that said, the GDP data will be thoroughly overhauled at the end of the month. Forecasts could change significantly with that new information, so we are refraining from pounding the table about near-term growth and what it may mean for the tapering decision.”

"The script’s still being writtern here, we stil have more to go," Zandi says. My gut tells me that the current data might look a little softer than they do right now.  when we look back and evaluate history there may be more of an effect [from the sequester] than we thought."