July 6th, 2018

Morning Note

June 2018 US payrolls preview

  • It almost goes without saying that the US labor market is on a tear. At 3.8% the unemployment rate is at the lowest level since the 1990’s boom, which in turn was the lowest level since the late 60’s. Payrolls growth has shown no signs of slowing down meaningfully. Here’s the first chart, showing the monthly change in payrolls, which is still trending at around 200k. Such gains are consistent with further declines in the unemployment rate and above potential/trend GDP growth:


  • What’s more, the YoY percentage increase in payrolls is even accelerating:


  • The commentariat is attributing the labor market over-performance to the ill-timed and ill-designed fiscal easing – the Trump/GOP tax cuts. According to the April IMF fiscal monitor, the so-called cyclically adjusted primary budget deficit[1] is set to widen to 4.2% next year from 3.3% this year and 2.5% in 2017. Fiscal policy is set to tighten as late as 2020, with the deficit narrowing to 3.5% of GDP. Note that by one important measure the monetary policy stance is still accommodative: the short real rate is about zero (federal funds effective rate minus the annual change in the PCE core price index); and slightly negative ex ante (federal funds rate minus the 1-year inflation swap rate). In other words both fiscal and monetary policy are still stimulating demand, even though those tailwinds are set to fade, in particular in case of monetary policy.
  • Our favorite early cyclical labor market indicator, workers on temporary payrolls, hasn’t peaked yet, suggesting payrolls growth to remain solid in the near term future. Business cycle surveys – the PMI’s – are solid as well. Economic forecasts call for further above potential growth next year (2.4% at pixel time, down from expected growth of 2.9% this year). And while trade is increasingly mentioned as an economic tail-wind, the tariff proposals that are doing the rounds would not meaningfully raise the US overall barriers to trade as we explained in Tuesday’s Comment. In our view it’s not the tariffs themselves, but confidence effects that may drive investment lower that’s the key risk.
  • But back to the labor market data and what it will mean for markets. While there don’t appear to be any signs yet of payrolls growth slowing down anytime soon, slow down it will: either on its own, or by tighter monetary policy. Regarding the former, we should be mindful of the labor market running into supply side constraints. For example, the ratio between the number of officially unemployed workers and job openings has fallen below 1.0, probably for the first time since the 1990’s boom – or possibly for the first time ever:


  • The latest Job Openings and Labor Market Turnover Survey (JOLTS suggests vacancies are still in an upward trend. At the same time, the hiring rate (hires as a percentage of the total employed population) has stabilized; the firings rate is still falling; while the quits rate (workers who voluntarily quit their jobs) continues to advance.


  • In other words, the labor market has become so tight that employers are hesitating to fire the ‘rotten apples’; workers are quitting their jobs in droves in hopes of finding better employment elsewhere, and finding plenty of choice; while employers find it more difficult by the day to find suitable candidates and are being forced to lower standards for applicants. And there’s plenty of anecdotal evidence of employers lowering standards, ranging from employers hiring retired babyboomers or convicts to scrapping drug tests.
  • Something has to give here, and chances are it probably isn’t demand slowing down anytime soon. That suggests supply constraints will increasingly start to bite. And while wage growth is still very modest (contained between 2.5% to close but below 3% according to the headline private hourly earnings measures), anecdotal evidence of a very tight labor market will give the Fed little choice but to continue raising rates at a quarterly pace. It’s therefore quite surprise that markets remain quite skeptical of the Fed raising rates much further.


[1] This is what the budget balance excluding interest payments would be if the economy were at full employment – as it is now.