Economic Insights - January 7 - 11, 2019
- A most excellent jobs report: The December employment report was the best of this expansion. Not only was job growth fantastic, but the labor force participation bumped up and wage growth accelerated to match this cycle’s peak.
- Weekly highlights: Last week, Federal Reserve speakers and the Federal Open Market Committee minutes comforted markets. A key leading indicator for business investment spending flashed warning. The yuan rallied by the most in 13 years.
- Investment implications: A good jobs report and a soothing Fed fueled the year-to-date stock market rally. However, the more bullish sentiment may not last.
A most excellent jobs report
The strength in the December jobs report ran deep. Job growth surprised sharply to the upside, 312,000 jobs were added versus 184,000 expected. Revisions were healthy - 58,000 jobs were added in the prior two months. This strength translated into a three-month moving average of 254,000, the best since September 2016.
The best news was a pick up in the labor force participation rate. The unemployment rate increased two-tenths of a percentage point. But it increased for the right reason, more people joined the labor force. The participation rate increased 0.2 percentage points to 63.1%, tied for the highest level since March 2014. Labor force participation has been trending around 63% over the last five years, at a time when an aging population suggests that it should be moving down.
The labor force participation rate for workers 25 to 54 years old, or prime age, has been moving up since bottoming in 2015. According to Bloomberg, it has accelerated as people transitioned from not wanting a job to taking a job. In other words, discouraged workers aren’t discouraged any more.
These transitions from the sidelines to employed have kept job growth buoyant even as the unemployment rate has gotten very low. The recent upturn in wage growth has probably propelled even more workers off the sidelines. And, there may be more room for this trend to playout. The number of discouraged workers is still elevated compared to its pre-recession low. The labor force participation rate for prime age male workers is below the last expansion’s high. Some slack left in the labor market also likely explains why wage growth has been muted up until recently.
Overall wages grew 3.2%. But wage growth for less-educated workers was impressive. Hourly wages for construction workers were up 4.2%; retail wages surged 4.6%; leisure and hospitality wages were up 4.3%; and wholesale trade wages were up 4.1%. Labor shortages likely explain the faster wage growth. A recent Conference Board paper showed that the labor force without a bachelor’s degree has been shrinking. Continued higher wages for less-skilled workers could reverse the decades-long trend of elevated income inequality.
The move up in wages has some analysts worried about recession. Ahead of a recession, labor costs start to chip away at corporate profitability. While wage growth picked up last year, unit labor costs fell with a rise in productivity. Moving into this year, even though wage growth should move up further, more people reentering the labor force could keep pay growth from overheating.
The US economy may be slowing down from its super strong speed in mid-2018, but a healthy labor market will keep growth from decelerating too much. A few more people transitioning from out of the labor force back to work likely will keep job growth decent in the coming months. Broad-based wage growth will keep consumer spending well supported.
Have a little patience: Jerome Powell’s January 4th dovish statements calmed investors. Last week, more Federal Reserve (Fed) speakers confirmed that the Fed is moving towards taking a breather. Voting member Boston Federal Reserve Bank President Rosengren stated, “I believe we can wait for greater clarity before adjusting policy.” Chicago Fed President Charles Evans stated, “We have good capacity to wait and carefully take stock of incoming data and other developments.” But, he also stated the Fed should ultimately raise rates to 3.0% to 3.25%. On January 4th, Cleveland President Loretta Mester stated, “I want to take the time I have to actually evaluate how the economy is going.” While Ms. Mester is a non- voting member this year, she leans hawkish. So, her cautious statements are a big deal.
The December meeting minutes were more dovish than the policy statement. A key sentence was, “many participants expressed the view that, especially in an environment of muted inflation pressures, the Federal Open Market Committee (FOMC) could afford to be patient about further policy firming.”
Since mid-December, the market has increasingly been pricing in no rate hike in March. The current market-based probability of a March pause is 96.7%. If the Fed unexpectedly reverses course, the market will likely violently protest.
A warning sign: The National Federation of Independent Businesses’ Small Business Optimism Index declined slightly. But below the headline index was a more disturbing data point, capital spending plans dropped sharply. While one statistic does not make a trend, this indicator is worth watching. This aligns with other weakening business surveys, which Bob Baur discussed in the most recent quarterly Economic Insights. Capital spending plans and other measures of business confidence are good leading indicators of future business investment spending. So this drop could foretell a fall in investment spending this year.
Strengthening yuan: According to Bloomberg, last week the yuan strengthened by the most since 2005. This strengthening is coming about despite weakening economic data including most recently a very weak producer price reading. Better prospects for trade, a more dovish Fed, and falling US interest rates likely explain the gain in the currency. While a strengthening yuan is not good for Chinese exports, it may provide more room for policy makers to ease without triggering fears of currency destabilization.
A strong jobs report alleviated fears that the US was heading towards a sharp slowdown. But, post-report Fed speakers were cautious. The broader market turmoil of late last year and lack of meaningful inflation pressures weighed more in FOMC member minds.
While the employment report and a more dovish Fed are positive for stocks, market risks remain. China’s slowdown has probably not fully been reflected in US company earnings. While bellwether high-yield credit spreads have fallen some, they remain elevated compared to their early October lows. This suggests credit stress remains.