US wages still contained

Via Westpac:

The US economy delivered another strong employment gain in August, with nonfarm payrolls rising 201k. While that was a little above our expectation, the August report also cut 50k jobs from the prior two months. The 3-month average now stands at 185k – coincidentally the exact figure we forecast for August.

Despite the revision, the 3-month average of 185k is still very strong, consistent with a 1.5% annualised pace of employment, well ahead of population growth at 1.0%, and above 2017’s 182k average. It is also worth noting that these outcomes follow strong gains over the first five months of 2018 – an average gain of 220k per month.

Based on the business surveys, particularly the ISM’s, the US is likely to see a continuation of robust employment growth. With the participation rate stable in recent months, this trend is likely to result in the unemployment rate edging lower still from the current multi-decade low of 3.9%.

While the unemployment rate signals little to no slack remains, underemployment can fall further. Currently this measure of slack is the lowest it has been since April 2001, but it is still 0.6ppts above the low back to 1994. This indicates employers can increase their output by increasing the hours of existing staff rather than finding new staff.

Also relevant when assessing available slack is participation. The headline participation rate has been little changed since the beginning of 2014. However, this masks still-low participation amongst prime-aged workers – offset in aggregate by the growing share of the population above the age of 55, for whom the participation rate is much lower.

While the participation rate for those between 25 and 34 has risen materially since its 2015 low to be back near its preGFC level, participation for those between 35 and 54 remains abnormally weak. This is also the case for those between 20 and 24 – although arguably this is primarily because these individuals are spending more time in education before moving into the workforce rather than difficulty in finding suitable employment.

Where does this leave wages? While the August 2018 outcome of 2.9%yr for hourly earnings is the strongest outcome since 2009, a further sustained acceleration materially above 3.0%yr will be hard won.

Employers are finding appropriate staff hard to come by, but they are also very focused on costs. Given the above opportunity vis a vis underemployment, employers are likely to run their current workforce harder before bidding up wages to attract new staff. Even then, supply from outside the labour market is likely to at least partially offset demand. All else equal, this should keep upward momentum in wages fairly sedate.

If, as we expect, hourly earnings and hence aggregate household income are restrained over the coming year, then households’ discretionary spending capacity will remain restricted. Note, if inflation tends back down to 2.0%yr, earnings growth near 3.0%yr will equate to real income growth of just 1.0%yr.

While the above slack will likely have been worked through by mid-to-late 2019, by then additional headwinds will have built up. Domestically, tighter financial conditions due to four more rate hikes by the FOMC to June 2019 will weigh further on consumers’ limited discretionary spending capacity. From offshore, an elevated US dollar and tariff retaliation will further impede momentum. US labour demand is then likely to abate, creating a new headwind for income growth and hence consumption. This combination of domestic and external headwinds is key to our belief that the US rate cycle will peak in June 2019, as growth returns to trend while wages and inflation are kept in check.

That is spot on as the base case. My question is whether that will be enough for El Trumpo. I don’t think so. Hence I see more stimulus via infrastructure as high risk.