America first

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America first

The Bureau of Labour Statistics in the US has released their monthly report showing changes in employment. The figures released have been surprisingly good, sending a clear message that the labour market in the US remains strong.

Unemployment at 3.8% is at its lowest level in over 18 years. Vigorous demand for labour is making workers more confident. They are looking for better opportunities as demonstrated below. The chart is based on the share of job leavers as a proportion of those out of work. It shows the proportion now stands at 13.8%, the highest since 2000, indicating that people are leaving their jobs confident that they will soon find better opportunities elsewhere.

US Job Leavers as Share of Total Unemployed

Source: Bloomberg, 31 May 2018

Momentum in the US jobs market continues to build despite rumbustious domestic politics, explosive geopolitics and a President starting a trade shooting war with long-time allies, all being potentially damaging to corporate confidence.

In fact, 223,000 new US jobs were added in May, more than the forecast 190,000. This year 1.04 million jobs have been created, outpacing the same milestone by one month in each of the past two years.

The question now is whether momentum can be sustained. If more jobs continue to be created, the pool of skilled workers will diminish at a faster pace. In previous cycles, when unemployment fell rapidly, wages increased, input costs rose and general price levels accelerated, i.e. we got inflation. Employees’ earnings have increased for the 7th straight month and the total increase for the year to the end of May has gone up marginally to 2.7% from previous figure of 2.6% in April. So, why are interest rates not moving higher at a faster pace?

Federal Reserve (Fed)

To decide on necessary policy actions the US central bank is carefully monitoring economic data, including labour market readings. Keeping interest rates ultra-low is less appropriate when growth and employment conditions pick up. Therefore, rates have been rising since 2015 with 6 increases taking the level to 1.50% – 1.75% range.

However, at some point the Fed may feel the need to accelerate the rate increase. This may be required to signal their inflation beating credentials. They also appear to want more rate rises under their belts as the economy matures and reaches full capacity. Thus, in the event of recession or in response to a destabilising event, they will be in a better start position to lower rates again from a higher level.

With labour market data for May being better than expected, market participants are forecasting a high chance (86%) of an interest rate rise taking place at the next Fed meeting on Wednesday (13th of June).

Probability of Hike in June & Monthly Payrolls Increase

Source: Bureau of Labour Statistics & Bloomberg, 6 June 2018
If the pace of the US labour market keeps improving, downward pressure on unemployment and upward pressure on wages will intensify. For now, the current pace of wage growth is still too low for the Fed to achieve their target inflation of 2%; measured by the PCE Deflator (Personal Consumption Expenditure) currently at 1.8%. Historically, to achieve PCE inflation of 2%, average hourly earnings growth needs to be pointing north of 3% and firmly heading higher. Thus, we have one of this cycle’s conundrums; strong job creation has not translated into higher wages and higher prices.

It will be interesting to revisit the Fed ‘s decision next week, to see how they interpret labour market trends and how this interfaces with the process of gradual monetary policy normalisation underway.

PCE Inflation v Average Hourly Earnings Growth

Source: Bloomberg, 31 May 2018

Personal Finance