Friday's nonfarm payroll report was probably the most anticipated economic report in several years, but in the end it told us little we didn't already know. While the U.S. housing and manufacturing sectors continue to recover, the labor market is still stuck in second gear.
This leaves the Federal Reserve (Fed) in a sticky position and means that we're likely to see a more gradual tapering and a more muted rise in rates, as I explain below. But first, here's a quick look at three takeaways from the report showing we have yet to experience the long-awaited pickup in the labor market.
- Job creation is still slow. The U.S. created 169,000 net new jobs in August, below expectations of 180,000. July's rate of job creation was also much slower than originally thought, with July job growth revised downward to 104,000 from an initial estimate of 162,000. In addition, year to date, the U.S. economy has averaged 180,000 net new jobs per month. This is actually slightly below the 182,000 average of 2012.
- Labor participation continues to drop. While the unemployment rate has fallen significantly from a year ago, when it stood at 8.1%, part of this drop can be attributed to a lower participation rate, i.e. fewer Americans are engaged in the labor market. Today the participation rate stands at 63.2%, down from 63.8% last summer.
- Given the tepid pace of job creation, wages are growing fairly slowly. While hourly wages did tick up a bit in August, they are up just 2.2% year-over-year. This is barely ahead of the inflation rate and close to the 4-year average. In short, there is no acceleration in wage growth.
So where does leave the economy and the Fed? The good news is that there was no summer swoon similar to the past several years. The bad news is that in regards to the labor market, we're basically where we have been for the past several years: grudging improvement, but not nearly quick enough to produce meaningful wage growth.
And this leaves the Fed in a sticky position. While other measures of activity improved in August, a more robust jobs market continues to elude the Fed. This means that though a September taper is still the most likely scenario, there is now more uncertainty around tapering's start date and an increasing likelihood of a more gradual taper, what I'm calling a "taper lite." The Fed has repeatedly stated that its reduction in bond purchases will be data dependent. As a result the Fed will likely adjust the speed and magnitude of its taper adjustments along the way. In short, absent a pickup in jobs growth, quantitative easing may be around longer than some expect. In addition, the Fed may also be more inclined to follow the new Governor of the Bank of England and provide further guidance on how long short-term rates will be anchored at zero.
For investors, the implications were obvious one second after the jobs numbers were released. Interest rates are likely to rise over the next six to 12 months, but not in a straight line. With real rates already up more than 150 basis points from their 2013 lows, much of the rate adjustment has already occurred. Going forward, I continue to believe that the backup in rates will be volatile and characterized by lots of back and forth. For investors, this means that while you generally want lower durations, there will be periods when nimble investors may actually be able to make money being long bonds.