The lemon under the US jobs bonnet

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From Westpac’s excellent Elliot Clarke:

Ahead of the August employment report, nonfarm payrolls had maintained a robust pace of growth through 2014, averaging 230k new jobs per month. While prone to greater volatility, the household survey had been similarly positive, with employment growth averaging 252k per month and the unemployment rate falling from 6.7% in March 2014 to 6.2% as at July.

While the unemployment rate rounded down to 6.1% in August, the remainder of the August detail was unquestionably soft. The household survey reported just 16k new jobs in August; that followed the creation of only 131k jobs in July, but 407k in June and a 2014 average of 223k.

The 142k August payroll gain was well below the average to July of 230k, which was also the market consensus expectation for August(Westpac 195k). What’s more, net revisions to the previous two months were negative, with 28k jobs revised away, leaving 2014 month-average payroll job growth at 215k.

While both surveys’ month-average pace for the year to date remain very healthy, and also up on 2013, both nonfarm payrolls and the household survey have seen a significant loss of momentum.

One month does not make a new trend, but it does provide an opportunity to highlight the importance of consistent momentum.

Simply, continued healing at pace of the labour market is critical for the full removal of the ill effects of the GFC. This was made clear recently by Chair Yellen in her August Jackson Hole address, with reference to two new empirical estimates of slack.

Researchers at the Board of Governors and the Kansas City Fed have both developed Labour Market Conditions Indexes (LMCI) which seek to distil the signal from 19 and 23 labour market indicators respectively (including the key metrics discussed above) into one quantitative estimate of the pace of healing.

The Kansas City Fed also estimates a second additional factor which corresponds to the level of slack still apparent in the labour market. Measured relative to historic-average levels, the Kansas City LMCI level of activity factor gives greater clarity on how the current environment contrasts to a ‘historically normal’ labour market.

Assessed together with the momentum factor, it provides an estimate of the time necessary to eradicate remaining slack.

On the latest Kansas City Fed estimates (to July), if the pace of progress experienced through 2014 to date continues, then the remaining abnormal slack will be depleted by September 2015 – consistent with our expectation of a first rate hike in late 2015. But, if the pace of healing slowed to its average for the entire recovery (back to November 2009; the first month the unemployment rate fell), then it would take another year (August 2016) for the labour market to ‘return to normal’.

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While thorough, the problem with the LMCI approach is that it can be difficult to interpret, with no direct, individual relationship with any particular labour market variable. However, with the LMCI detail as background, comparing current payrolls growth to relevant period averages gives a simple but effective gauge of immediate momentum and the potential consequences for slack eradication. (Note, analysis of the Board of Governor’s LMCI highlighted that, in the recovery so far, momentum was driven by private payrolls and changes in the unemployment rate. So using the change in payrolls as a basic, immediate guide to current momentum and remaining slack has merit. But, it should also be remembered that declining unemployment owing to lower participation passes as momentum.)

At 215k (230k in July), the 2014 month-average pace of nonfarm job creation is still well above the full-recovery average of 175k.

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However, for Q3 to date only, the month-average pace of job creation stands at 177k, in line with the 175k full-recovery average which would not see a return to ‘normal’ levels of slack until mid- 2016.

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Herein then we see that there is still a long way to go in restoring the US labour market to full health, and that there is no guarantee this will be achieved by mid or even late 2015. With respect to policy expectations, there is therefore a need for restraint.

The FOMC continues to highlight that the pace of policy normalisation will remain dependent on the data flow. Inflation will remain an ever present factor for policy; but on past experience, we are unlikely to see persistent inflationary pressures at or above the 2% medium-term FOMC target absent further, material improvement in the labour market. If this remains the case, a return to the pace of job creation seen in the six months to June (circa 228k) is a necessity if we are to see rate normalisation begin in late 2015.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.