A Slightly Complicated Employment Report
The market’s initial reaction to the Employment Report does not recognize the implicit strength of the economy. People may focus on the 98,000 rise in payrolls, a smaller increase than expected, and the 0.2% rise in average hourly earnings, while not sure how to interpret the notable decline in the unemployment rate from 4.7% to 4.5%. As we see the report, hiring is becoming ever more difficult because unemployment has declined to the point that labor has become scarce, which is evidence of strength, not weakness.
Businesses are still trying to hire, as is clear from the Job Openings report, which shows elevated numbers of jobs available. Firms have been reporting anecdotally that it has become very difficult to find suitable candidates to fill their job vacancies. This is consistent with a slowdown in hiring. A slower pace of hiring becomes inevitable as the pool of unemployed shrinks. Firms can’t hire people who aren’t out there. But as they need to hire, they continue to push the unemployment rate ever lower and exacerbate inflation pressures on wages.
On a year-over-year basis, wage inflation hit 2.8% in February, only slightly less than 2.7% in March. These are solid increases in wage inflation after holding around 2.0% just a year ago. We should expect more wage acceleration in the months ahead, despite the average hourly wage rate being depressed by the changing mix of new hires. Two years ago, the unemployment rate for college educated workers hit rock bottom at around 2.5% and has oscillated around this level ever so slightly over this period, despite all the job growth enjoyed by the economy. These are our highest wage earners. Our least educated workers, those who also earn the least, have experienced the most rapid job growth. Those without a high school diploma have seen a decline in their unemployment rate from 7.4% in March 2016 to 6.8% in March 2017. Hiring so many lower wage earners depresses the average wage. But make no mistake, finding suitable workers is becoming more difficult at every level and this will continue the upward trajectory of wage inflation.
The implications for monetary policy are fairly straightforward in our judgment. Nothing in the latest report suggests the Fed should deviate from its unofficial plan to tighten policy two more times in 2017 and to begin the process of reducing its balance sheet in Q4. Indeed, the risk is that labor inflation could accelerate faster than expected, driving up inflation, and forcing the Fed to move up its timetable.
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