Economic Insights - October 30 - November 3, 2017
- No Halloween for payroll: The labor market did not take time off for Halloween, and October’s monthly payroll growth was a robust 261,000. The number was slightly below consensus but is strong enough to allow the Federal Reserve (Fed) to increase short-term interest rates by another 25 basis points (bps) in December.
- Meet the new boss: President Trump officially nominated Jerome Powell as the new Fed chair, replacing Janet Yellen when her term expires on February 3, 2018. A relatively smooth confirmation is expected. Mr. Powell is a “continuity” candidate and is expected to follow the same measured approach to monetary tightening as Ms. Yellen.
- The Bank of England joins the club: Meanwhile, across the pond, the Bank of England raised rates for the first time since 2007, citing a pick-up in inflation. At 0.5%, the policy rate can hardly be described as restrictive, though Governor Mark Carney signaled that a couple of further rate hikes may be necessary to keep price growth in line.
No Halloween for payroll
While most of the United States was busy enjoying Halloween, the labor market was not taking any time off. As expected, monthly payroll for October showed a strong rebound from the natural-disaster induced weakness the month before. While the rebound was solid, some of the details were mixed.
But first the numbers: headline payroll grew by 261,000 while average hourly earnings were unchanged in October, putting the year-over-year gains at 2.4%. The three-month moving average of payroll growth is now 162,000, still well above what is required to keep the labor force in equilibrium. The unemployment rate fell further to 4.065%, and the broader U-6 rate is down to 7.6% (it is more than likely that the unemployment rate will breach 4% very shortly). With October’s gains, the jobless rate has reached a 17-year low. So, what’s not to like about this generally positive picture?
In its broadest sense, the resumption of strong payroll growth is very supportive of continued economic strength heading toward the end of 2017. With the labor market arguably below full employment, there are two primary signs of concern: the weakness in real wage growth and a continued drop in the labor participation rate.
Wages stay flat:
The lack of progress in average hourly earnings despite the strength in the labor market is extremely perplexing. At this point in the cycle, with over nine million jobs created, there should be more wage pressure. There may be deeper structural reasons at work here, including those related to productivity and skills mismatch. The lack of wage inflation is one of the key reasons why inflation has remained persistently below the Federal Reserve’s (Fed’s) target of 2%.
Where are all the workers?
The other concerning issue is the low level of labor force participation. The labor-force participation rate, a measure of potential workers who are in a job or want to be, fell last month to its lowest reading since May. Part of the reason may be structural – the United States is undergoing a demographic shift like other developed nations and its work force is getting older. As a result, there are simply not enough people entering the workforce. Another reason is skills mismatch. With the hollowing out of manufacturing, a vast number of workers lack the skills for the types of jobs being currently created in the economy. As a result, even if they want to join the workforce, they don’t have the relevant skill set to be able to do so.
These are both troubling signs in an economic expansion that is soon to reach its second longest in duration since World War II. But over the short-term, the return to strong hiring in an increasingly tight labor market continues to support the Fed‘s program of rate normalization, with the odds now clearly in favor of another increase in December. Over the longer-term, if inflation doesn’t move up as robustly as the Fed expects, it may have to revisit its reliance on the Phillips Curve as a key input into its monetary decision-making process.
Meet the new boss
Speaking of the Fed, two days after the actual Federal Open Market Committee (FOMC) meeting, President Trump officially nominated Jerome Powell to be the new Fed chair, replacing Janet Yellen when her term expires on February 3, 2018. A relatively smooth confirmation is expected. President Trump also has four Fed governor vacancies to fill, although it could only be three if Yellen serves the remainder of her term as governor, which expires in January of 2024; possible but unlikely.
At age 64, Powell comes to the position of Fed chair with a law degree (the first Fed chair in over 30 years without a PhD in Economics) and a varied career in law, investment banking, and government.
Compared to the present Fed chair, Janet Yellen, Governor Powell is generally characterized as “like minded” on monetary policy and will likely maintain consistency and continuity in the pace and magnitude of federal funds policy rate increases. He has never cast a dissenting vote during his term as governor, although in September 2012 when then-Fed chairman Ben Bernanke announced QE3, Powell reportedly disagreed and pressed for a “clarification” of the Fed’s goals, establishing what came to be called an “offramp” or “unwind” procedure for what proved to be the final phase of the purchase program. He then voted in favor of its implementation.
His recent public comments on monetary policy are basically interchangeable with those of Janet Yellen. He is generally rated “neutral” (neither dovish nor hawkish) compared to other members of the Fed Board of Governors. In a recent compilation, his projected federal funds rate at year-end 2018 was 2.13%, in line with seven other members, which was the largest group and included Yellen and Vice chair Bill Dudley. He is known as a “consensus builder” and is reported to be well-liked and respected by colleagues and staff within the Fed.
More open to de-regulation?
We feel his leadership on monetary policy itself, is not likely to represent a structural shift over the medium-term; with a bit of caution: Jerome Powell the governor could be different than Jerome Powell the Fed chair. The area where he is most likely to be different is regulation. Fed Chair Jerome Powell is likely not to advocate for wholesale departure from the Volker and Dodd-Frank regulatory environment. He feels that higher capital and liquidity requirements, along with more rigorous stress tests, have made the financial system safer and should be preserved for large banks. But, he also feels that the Volker rule should be re-written to exclude smaller banks.
In other news, the Fed stayed put:
Amid the monthly payroll report and the news on Powell, the FOMC met, and as expected, produced no change in policy. The meeting was the first for newly appointed Fed Governor Randal Quarles, who was appointed by President Trump in July and confirmed by the Senate in October, and who will serve as vice chairman for supervision; the Fed’s “top cop” as far as bank regulation is concerned. Aside from positive identity of the next Fed Chair, the main question was whether the FOMC would proceed with another policy rate boost prior to year-end. Of course, the Fed never allows this question to be answered directly, but the FOMC statement was upbeat enough about the growth outlook to guide the market to another rate hike in December. Futures traders after the meeting put an 87% likelihood on another 0.25% federal funds rate increase at the December FOMC meeting.
The Bank of England joins the club
On the other side of the pond, the Bank of England (BoE) raised rates for the first time since 2007, citing a pick-up in inflation. A policy rate of 0.50% can hardly be described as restrictive, though Governor Mark Carney signaled that a couple of further rate hikes may be necessary to keep price growth in line. Rates were lowered 25 bps in 2016 after the United Kingdom voted to leave the European Union, so this lift removes the extra-stimulus and brings the BoE back to where it has been for much of the past decade. Still, the Fed and the BoE are the only major central banks tightening policy.
A unique problem:
Inflation has been accelerating all year in the United Kingdom. This may sound a little strange since major developed-market central banks are currently waging a war against low inflation. The catalyst is Brexit, which sent the pound sterling down about 15% versus the U.S. dollar and led to imported inflation. A weaker currency tends to auger for higher consumer prices. Products from the rest of the world immediately become more expensive. At the same time, UK exports have become far more competitive on the world stage. Increased demand in turn has allowed UK businesses the room to raise prices.
It’s amazing how fast inflation accelerated. The UK’s version of core inflation was up 2.7% year-over-year in September, according to the Office for National Statistics. Core prices in the United Kingdom exclude food, energy, and tobacco products. The measure averaged just 1.3%-1.4% year-over-year in 2016, and was 1.2% in October 2016. This shows how quickly inflation can pick up, even in a relatively large, and developed economy. More support for additional rate hikes can come from the booming labor market in the United Kingdom, with an unemployment rate of 4.3%, a 42-year low. The big question the BoE will have to grapple with is how to balance the emergence of higher inflation with the prospect of tighter financial conditions in the backdrop of a very uncertain disentanglement from the European Union.