The monthly nonfarm payrolls report (aka. the “jobs report”) is one of the most important economic reports investors follow each month. Seen as both an important gauge of the economy’s momentum, and a major driver of Fed policy, the report rivals GDP in terms of its overall significance.
Many investors view this report through a “more is better” lens, but that may soon no longer be appropriate. While our President-elect ran on a platform dedicated to creating jobs, the reality is that more than 15 million jobs have been created since the labor market bottomed in 2010, and our economy is getting close to full employment.
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At this stage of the economic cycle, it makes sense to understand what “trend” job growth looks like so that we have a baseline from which to interpret future results. Today we’ll take a quick look at the current employment situation before discussing the pace of job growth needed to maintain a healthy labor market moving forward.
Last Friday we learned that 178,000 jobs were created during November. The unemployment rate fell to 4.6% (lowest since August 2007) and the U6 rate fell to 9.3% (lowest since April 2008).
These figures are promising, and tell an interesting story that we must pay attention to.
Our country seems to always have a mantra of “more is better.” Unfortunately, that is not always the case, and this type of thinking is partly responsible for the boom and bust cycles that repeat endlessly.
With the unemployment rate at or below what most economists consider full employment, it raises the question: How much better can the labor market get? And what are the consequences if we continue to experience above-trend growth?
Over the last five years, average monthly job creation has averaged around 200,000 jobs. This is a fast pace relative to historical experience and is unlikely to continue in the years ahead. But in order to understand how job growth will impact the economy, we need to have a basic understanding of what normal, or “trend” growth looks like.
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Trend employment growth is defined as the monthly rate of job creation that is required to hold the unemployment rate constant at a level associated with full employment. That level today is widely viewed as around 5%. At this level, economic growth and inflationary pressures are moderate but not excessive.
One thing to be aware of is that the trend growth rate is not a function of historical averages. Rather, the job growth needed to stabilize unemployment at any given time is a function of current economic conditions. In particular, it’s reflective of two primary variables: the population growth rate and the labor force participation rate.
Before we get into those, it’s important to understand that the economy rarely operates at the trend growth level. Instead, we go through expansions where excessive job creation occurs, followed by recessionary periods where many jobs are lost.
You can see the nature of this boom and bust cycle in employment in the chart below. The dashed line shows average monthly job gains, while the solid blue line shows an estimate of trend growth (gray bars are recessions).
Notice that the blue trend line is not constant. This is because, as mentioned earlier, trend growth in an economy is primarily a function of population growth and the labor force participation rate. As those variables change, trend job growth will fluctuate.
Back in 1960, the economy needed about 60,000 new jobs each month to maintain full employment. By 1980, that figure had risen to roughly 160,000 as a result of an increased birth rate and a rising labor force participation rate -- as more women entered the workforce. During the 1990’s, trend growth sat around 140,000 before falling to almost 50,000 in the aftermath of the financial crisis. It has subsequently been on the rise.
So how many jobs per month does our economy need to create in order to maintain current employment levels?
Based on data from the Federal Reserve Bank of San Francisco, trend growth now sits between 50,000 and 110,000 jobs per month. The actual figure is probably closer to 75,000, but the nature of this calculation doesn’t lend itself well to specificity without hindsight.
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The reason is because both population growth rates and labor force participation rates are difficult to predict; the latter being more difficult.
Take the following chart as an example (courtesy of the FRBSF). This chart shows trend job growth under four possible scenarios.
The leftmost bar shows the job growth needed if the overall labor force participation rate (LFPR) remains constant at current levels. The next bar shows trend growth if LFPRs for the four primary age groups remain constant (different age groups have different LFPRs). The third bar looks at a hypothetical scenario in which prime-age workers come back into the labor market, driving the LFPR up for that group by 0.3% annually. Finally, the last bar looks at another hypothetical situation in which both prime and young age workers increase their LFPR.
As you can see, under all scenarios the largest number of jobs our economy must add each month to maintain full employment is about 110,000. And that figure could be as low as 50,000 under certain conditions.
The key takeaway here is that job growth can slow substantially from its current pace and still remain at or above trend, a signal of continued labor market health. Therefore, if we see declines in the headline job creation numbers, don’t worry until they begin to fall below trend.
Interestingly, if we continue to add jobs at an above-trend rate (the “more is better” thesis), there could be consequences to pay. Typically, overly-tight labor markets result in rising wages that lead to higher levels of inflation. This would drive interest rates higher and would likely result in losses for fixed income investors as well as lower stock prices.
Perhaps instead of trying to create “as many jobs as possible,” our goal should be to maintain healthy and sustainable levels of employment. The booms are always nice, but above-trend growth by definition always results in an eventual reversion-to-the-mean … aka recession.
The preceding content was an excerpt from Dow Theory Letters. To receive their daily updates and research, click here to subscribe.
