Originally posted at Briefing.com.
The Employment Situation Report is considered by many market participants to be the most influential economic release of them all. We can understand why given the message it provides on the most important driver there is for the economy: employment.
When more people are working, more people are spending. When more people are spending, more businesses are investing to meet the increased demand. When more workers are earning money and profits are increasing for businesses, tax receipts go up for the government, which presumably lessens the government's need to borrow money to fund all of its spending.
See Bank Tightening Suggests Layoffs Ahead
It's a positive feedback loop that leads to strong economic growth. The only problem is that this positive feedback loop has been more like the hyperloop in recent years, i.e. long on promise but still short on delivery.
In the five-year period from 2002-2007, total nonfarm payrolls increased by 7.4 million, real GDP growth averaged 2.8%, and personal consumption expenditures growth averaged 2.9%.
Over the last five years, total nonfarm payrolls have increased by 12.3 million. During that time, real GDP growth has averaged just 1.9% while personal consumption expenditures growth has averaged 2.2%.
Something has changed to help account for the lackluster growth we continue to see—or perhaps the more important point is that something hasn't changed. That something is average hourly earnings growth, yet the good news is that might be changing.
Fixating on the Wrong Item
Over the last five years, average hourly earnings growth has been pretty much flat, averaging 2.1% year-over-year. Since December 2015, however, average hourly earnings growth has averaged 2.5% year-over-year.
With the release of the April Employment Situation Report, it was shown that average hourly earnings increased 2.5% year-over-year. It was also shown that nonfarm payrolls increased by 160,000 (Briefing.com consensus 207,000). The latter was below the prior 12-month average of 232,000 and the prior three-month average of 200,000.
A lot of people want to focus on the slowdown in job growth. We think that's too much of a headline fixation.
Frankly, with a civilian labor force of 158.9 million, and an employed level of 151.0 million, the difference between the actual nonfarm payrolls number and the consensus estimate isn't nearly as pronounced as it might appear at first blush.
If one wants to fixate on a headline figure from the April report, it should be the 2.5% year-over-year increase in average hourly earnings.
Why?
There are two reasons really: (1) higher wage growth should lead to higher spending and (2) higher wage growth should lead the purportedly data-dependent Federal Reserve to raise the fed funds rate soon—maybe even in June.
Casting a Shadow
The fed funds futures market isn't buying that last thought at all. Following the release of the April employment report, the fed funds futures market reduced the probability of a rate hike at the June meeting to 8% from 13% the day before.
We suppose the deceleration in job growth and the drop in the participation rate to 62.8% from 63.0% had plenty to do with that handicapping. They were downshifts that probably left a number of people convinced the Fed will refrain from a rate hike in June, cognizant that US growth is still shaky and that the "Brexit" vote is still undecided.
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Fair enough.
Clearly, it would be a jolt to the markets if the Fed raised the fed funds rate in June. The Fed probably won't, because it is still scared of its December rate hike shadow.
That rate hike, by the way, came at a time when the Fed knew average hourly earnings growth was up 2.3% year-over-year (it was subsequently revised to 2.4% year-over-year).
It's good economic news to see the pickup in average hourly earnings. It could be—and still needs to be—stronger to produce the sustainable and stronger economic growth of yesteryear, yet it is trending in a manner that should not escape the Fed's attention, particularly with energy price comparisons due to get easier in the months ahead, unit labor costs rising on weak productivity growth, and both manufacturing and non-manufacturing companies reporting higher prices paid of late.
What It All Means
Most headlines will suggest the April Employment Situation Report was a disappointment. That's not an accurate assessment.
The April Employment Situation Report was mixed. It featured disappointing job growth (but not weak job growth) and encouraging average hourly earnings growth. Additionally, it also produced a 0.8% increase in aggregate earnings, which should be a good portent for consumer spending in the near term.
We think the report itself, though, created a real policy pickle for the Fed since the year-over-year gain in average hourly earnings offers some data-based grounds to raise the fed funds rate in June.
The Fed will probably hide behind the "Brexit" vote as a reason not to, but if it keeps shying away from raising the fed funds rate when it has the data to support another incremental step toward normalizing the fed funds rate, it may have to take a giant leap one day that won't be good for mankind or the stock market.
