Yahoo Finance 2 reasons why the economy looks ready for a rate hike
While negative recaps dominated the report’s post-mortem, two key metrics were glossed over that suggest the US economy may be better off than the preliminary prognosis indicates and may be able to withstand another rate hike: hourly earnings and long-term unemployment.
The May jobs report was, by many measures, disappointing. US companies added only 38,000 jobs last month, the lowest level in six years and well below the 155,000 expected by economists. And while the Verizon labor strike added noise to the numbers, its estimated impact stood at only 34,000.
But while negative recaps dominated the report’s post-mortem, two key metrics were glossed over that suggest the US economy may be better off than the preliminary prognosis indicates and may be able to withstand another rate hike: hourly earnings and long-term unemployment.
Ongoing improvements in both measures suggest slack in the labor market is on the decline. And it further complicates decisions made by the Federal Reserve and Chair Janet Yellen as they discuss and decide the path of monetary policy.
Hourly earnings are on the rise
First, wages are growing. Average hourly earnings rose 2.5% year-over-year, an uptick from the 2.0% level of recent months.
RBC Chief U.S. Economist Tom Porcelli wrote in a note that workers’ earnings have been increasing significantly.
“It is not only evident from a job leavers’ rate that remained near cycle highs but average hourly earnings that somehow managed to print on consensus of +0.2% and witnessed an upward revision to +0.4% the prior month,” he wrote of the monthly growth rate. “More anecdotally, we learned (again) from the Fed’s Beige Book that labor shortages are very real and run the gamut of skills, to boot.”
Wage growth since the Great Recession has hovered around 2%, and so an increase in both April and May above that level is notable. A “tight labor market” or a labor market with “less slack” implies there is a smaller supply of workers and that employers need to pay more as they recruit and retain their workforces. And all that suggests economy can withstand a rate hike.
Various measures of wages, including average hourly earnings and the employment cost index are trending higher, even if below pre-crisis levels, as seen below.
Meanwhile, wage and income expectations are trending higher.
In fact, according to the chart below, the labor market is currently tighter than it was in 2007. The JOLTS data in particular shows that people are voluntarily quitting their jobs at a pre-crisis rate, suggesting more confidence in the market.
Long-term unemployment is declining
Second, long-term unemployment is declining. Now, only 25% of those unemployed have been unemployed for 27 weeks and over, down from about 45% in the years following the recession. Less than 2% of the labor force has been unemployed for 15 weeks or longer. This important statistic suggests that the probability that an unemployed person finds a job in the near to medium term increases, again reducing the supply.
In a speech in April, Boston Federal Reserve President Eric Rosengren argued that employment was close to getting overheated given the low 5% unemployment rate at the time.
“The unemployment rate is now at 5% — relatively close to my estimate of full employment, 4.7%,” he said. “My concern is that given these conditions, an interest rate path at the pace embedded in the futures markets could risk an unemployment rate that falls well below the natural rate of unemployment.”
The declining unemployment rate, this time around, wasn’t anything to cheer. The unemployment rate fell from 5.0% in April to 4.7% in May, but the decrease was accompanied by a drop in the active portion of the economy’s labor force—known as the participation rate. This fell 0.2 percentage points to 62.6%. Additionally, a broader figure of unemployment that includes underemployed workers—known as the “U6” unemployment rate—stayed stagnant at 9.7%.
While we may be far from being “overheated,” the headline numbers alone don’t tell the whole story and some underlying strength despite the overall May disappointment should not be overlooked.
“The unemployment rate suggests we are at full employment and it is time to raise rates,” said Deutsche Bank’s Torsten Slok.
These pockets of strength come despite a significantly lowered chance that the Federal Reserve will hike interest rates this month. Futures contracts on Friday after the labor report priced in only a 4% chance of an increase in the Fed’s upcoming meeting, down from 35% at the beginning of last week.
However, given the disappointing headline nonfarm payroll number, he said a rate hike will likely be delayed given public concern that the economy is losing momentum.
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