Turn Down For What: Why is Job Growth Slowing?

by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab and Company, Inc.

Weaker job growth raises concerns, but there are reasons not to worry; and reasons to believe wage growth is stronger than traditional measures show.

Key Points

• Last Friday’s weak jobs report raised alarm bells about slowing job growth, but perhaps it’s natural at this stage in the cycle.
• Wage growth has been held down by both secular and “math” problems.
• Small business survey data, as well as alternate wage growth measures, suggest wage pressures are on the rise.

After the financial television networks’ typically-breathless countdown to last Friday’s jobs report, the release was a downer, at least as initially diagnosed. Today’s report will attempt to tell a more detailed tale of what’s going on with jobs, wages, and their potential impact on Fed policy.

May’s non-farm payrolls report showed a weaker-than-expected gain of only 138k; below both the consensus expectation and the recent trend. And although the unemployment rate ticked down to 4.3%, the details of that component of the release were weaker than expected; as the household survey employment series fell by 233k and the labor force participation rate (LFPR) fell 0.2 points.

On the subject of the LFPR, it’s important to highlight that it’s getting harder for companies to attract individuals who are not currently working. The pool of “discouraged” (but still available) workers has been falling precipitously during this expansion. About two-thirds of those not working represent older retirees; while the “other” category—stay-at-home parents, folks on disability, students, etc.—now represents about one-third.

Why job growth has waned

First, there was likely yet again a seasonal adjustment problem. As highlighted by High Frequency Economics (HFE), the May 2016 report was even weaker—payrolls were up only 38k—with similarly weak details. Thereafter, payrolls rebounded sharply. The average rise in payrolls so far this year—at 162k—is below the 187k from last year; but that includes the below-trend May reading. A rebound in the June and July data is expected.

Second, and more importantly, job growth is naturally waning given that we’re already likely at “full employment” and given the fact that we’re entering the ninth year of an economic expansion (see first chart below, showing a six-month average to smooth out month-to-month volatility). HFE notes that even 162k job gains per month—1.3% at an annual rate—is more than enough to keep both the headline (U3) and broader (U6) unemployment rates trending down (see second chart below).

Source: Department of Labor, FactSet, as of May 31, 2017.

Wages conundrum

More confounding has been the perceived-breakdown between lessening labor market “slack” and wage growth. At this stage in the employment cycle, wage growth should have been stronger based on historical trends and the “Phillips Curve,” which shows that inflation/wages and unemployment have an inverse relationship.

Using average hourly earnings (AHE)—the standard measure of wages—the year/year change was stable at 2.5% in May, slightly down from last year’s 2.6% average (see chart below). As noted by HFE, and “based on the ‘accelerationist’ theory of the relationship between unemployment and wages, wages don’t accelerate significantly until unemployment drops below the full employment level, and that likely just happened a few months ago.”

Source: Department of Labor, FactSet, as of May 31, 2017. Gray-shaded areas indicate periods of recession.

There are a few secular reasons for lower wage growth in this cycle; including weak corporate top-line revenue growth, low productivity growth and limited corporate pricing power. But there is also a “mix shift” problem in terms of how average hourly earnings are computed. This is why there are other—arguably more “accurate”—ways to measure wage growth.

Math problem

Notice how AHE were moving higher during much of the Great Recession (gray shaded area in the chart above). Does anyone think wages were actually moving up during one of the greatest economic contractions in history? Of course not; but that’s the way average math works. During that period, more folks on the lower end of the wage spectrum were losing their jobs; which biased up the average. Conversely, more recently, the sharpest job gains have been concentrated in the younger cohort—they are naturally at a lower wage level than older workers—therefore they bias down the average. In other words, Boomers are retiring from higher-wage jobs, while Millennials and Generation Z folks are getting new jobs at naturally lower wages.

The mix-shift problem is why the Atlanta Fed created their own “Wage Tracker,” which only measures wage gains for those folks who have been in the workforce for the full 12-month measurement period; thereby eliminating the “mix shift” problem of AHE. As you can see in the chart below, this measure of wage growth is running at 3.5% —a full percentage point higher than AHE. For what it’s worth, the Federal Reserve has both on its “dashboard” of employment indicators and is part of the reason we, and the market, believe a June rate hike remains firmly on the table.

Source: Federal Reserve Bank of Atlanta, as of April 30, 2017. Gray-shaded areas indicate periods of recession.

Skills gap

A budding problem for employers, as well as an explanation for slowing job growth, is a skills/worker shortage. Given that small businesses are the U.S. economy’s largest employers and hirers, the chart below from the National Federation of Independent Business (NFIB) highlights an important problem—the inability to find qualified workers for what are still high and rising job openings.

Source: National Federation of Independent Business (NFIB), as of April 30, 2017. Based on NFIB’s Small Business Economic Trends Data which is a monthly assessment of the U.S. small-business economy and its near-term prospects.

The same NFIB survey from which the job openings data comes also has a series measuring firms’ plans to raise workers’ compensation, seen in the chart below. As you can see it’s been trending higher for the past several years. HFE suspects that “some of the increase in compensation is separate from the basic wages captured by the average hourly earnings series.”

Source: National Federation of Independent Business (NFIB), as of April 30, 2017. Based on NFIB’s Small  Business Economic Trends Data which is a monthly assessment of the U.S. small-business economy and its near-term prospects.

In sum

The pace of job growth has slowed, but it’s likely not because the economy is weakening. It may even be because the economy is strengthening.

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