Labor Market Softens In March

by: Tim Duy

If the employment report falls on a holiday weekend, does it make a sound? Yes it does, at least when it comes in far below expectations, with 120k nonfarm payroll gain compared to a consensus of 205k. Treasury yields collapsed on the news, and are now once again hovering around 2 percent on the ten-year bond. In my opinion, this is yet another data point that confirms what has become my baseline view of this recovery - neither an optimist nor a pessimist should one be. The economy is grinding away at rate close to its potential growth rate, perhaps a little above. Certainly not a disaster in terms of expecting another recession, but also certainly also not a success story.

First off, should we be terribly concerned with the headline NFP number in and of itself? No. There is a lot of variance in the month to month changes:

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Reading too much into a single data point is simply a dangerous game. During the first quarter of 2012, the average gain was 211k a month. Part of the story is likely that warmer weather boosted the numbers in January and February, and there was some give-back in March - though note again the variance of this number. You almost always need some story to explain the month to month deviations from the trend. The question is whether or not this one data point should deter you from believing the trend is intact. My view is that it should not. That said, if you thought the last two reports were really indicative of the underlying trend, I would say that that was overly optimistic. Slow and steady, slow and steady.

On the surface, some good news in that the unemployment rate continued to decline:

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Still, the improvement was driven by a decline in the labor force, which fell by more than the decline in the number of unemployed. I tend to think Fed hawks will fixated on the decline in the unemployment rate itself rather than the underlying reason for the declines. One way to "solve" the unemployment problem is to drive people from the labor force, let their skills deteriorate, and ensure that a cyclical problem becomes a structural one. In other words, the view of St. Louis Federal Reserve President that the economy is operating near potential is almost certain to become a self-fulfilling prophesy given the unwillingness of the Fed to implement a more aggressive policy stance.

Support for the "structural not cyclical" view will be found in the persistence of long-term unemployment:

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That said, if we were truly operating near potential, one would not expect the wages of those employed to continue to stagnate:

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True enough, average hourly wages increased a nickel in March, but note that this was offset by a decline in hours so that average weekly wages fell. On net, not much help to support still weak disposable personal income growth:

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For further evidence that the economy remains well below trend, note the ongoing high levels of those employed part-time for economic reasons:

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An improvement, to be sure, but still a long way to go before the labor market is normalized.

As far as other views, a couple caught my eye this morning. The first was from spencer at Angry Bear:

The index of hours worked has been raising a red flag about the numerous other signs of stronger employment and an acceleration of economic growth. They are not showing the recent improvement that other employment data have been reporting Recently, unit labor cost has been rising faster than prices, implying margin pressure and very weak profits. To sustain profits growth, firms have to reestablish stronger productivity growth. The weakness in March employment is a strong indicator that business is trying to rebuild productivity growth and profits growth.

This bodes poorly for the sustainability of the recent upward trend in equities. Another issue is what does this mean for monetary policy? I think Ryan Avent (via Brad DeLong as the Economist server appears to be down at the moment) captures the general spirit:

This report will be widely analysed within the context of this year's political elections, despite the fact that the single most important influence on employment growth now and over the next four years will be the stance of monetary policy. As this report is consistent with recent Federal Reserve forecasts, indicating that the Federal Open Market Committee is satisfied with present employment trends, policy is unlikely to change in reaction to anything released today

The data is sufficiently disappointing as to not alter the view of the doves, and notably Federal Reserve Chairman Ben Bernanke, that there is no need to tighten policy in the near future, leaving the 2014 timing intact. Thinking about the trends as noted above, there is no reason on the basis of this report to believe that a significant deterioration in the outlook has or is about to occur, and thus no reason to expect this will nudge the FOMC toward another round of QE. This I find unfortunate because, as I noted earlier, the longer the Fed continues to operate policy along the post-recession growth trend the more likely it is that this will indeed become the new trend for potential output.

Bottom Line: A disappointing jobs report for those who expected the US economy was about to rocket forward, but one consistent with the slow and steady trend into which the US economy appears to have settled. And no reason to change the basic outlook for monetary policy - the Fed is on hold until the data breaks cleanly one direction or the other.