- The October nonfarm payrolls report (+214K) suggest that employment continues to grow above trend. The unemployment rate fell to 5.8% below the Fed’s end of year forecast. Both indicators suggest that the economy continues to support progress towards maximum employment.
- The labour market data strengthen the case for a Fed rate hike in June 2015.
Job growth remains strong in October
The employment recovery remains on track. US nonfarm payrolls advanced by 214K in October, following a gain of 256K the month before. The revisions of the past two months added 31K jobs. The change in nonfarm payrolls was slightly below the consensus forecast (235K). Looking at the details, the report shows signs of some payback after a particularly strong report in September. Only manufacturing gained 12K compared to the previous month. But job gains in other categories remain solid. In the period January – October, average job growth was 227K and the unemployment rate declined by 0.9 percentage points in this same period. Indeed, the unemployment rate in the household survey fell to 5.8% in October from 5.9% the previous month.
Underlying indicators improving…
The participation rate is a closely watched indicator by the Fed’s policymakers. This indicator shows the share of working-age people in the labour force. It edged up 0.1 percentage points to 62.8%, after two straight months of declines. The participation rate has been flat at low levels, despite the strong job growth. This is a result of workers retiring and people having left the labour force in the past due to a weak labour market and not returning. The Fed’s dilemma is whether loose monetary policy will bring these workers back to the labour market or whether additional easing will only encourage inflation pressures. We think that retired workers leaving the labour force is the key driver of lower participation rates, since a measure of unemployment that partially takes into account worker discouragement, the U6 report, continued its downward trend, falling to 11.5% in October from 11.8% the previous month.
…but wages remain sluggish
The missing piece in the labour market continues to be wage growth. The employment report showed that average hourly earnings remain flat despite the improvement of the labour market, reporting a 2% yoy change in October, far below the long-term average. For Fed Chair Yellen, the sluggish pace of wage growth is a reflection of the inability or unwillingness of firms to lower nominal wages during the recession, leading them now to be more conservative in rising wages to attract qualified workers. But as the degree of slack declines, she adds that wages could rise at a rapid pace. We think that we are at the beginning of this process. Indeed, wages reported in the US Employment Cost Index in the third quarter rose by 0.8%, the largest increase in six years.
Unemployment rate already within the Fed’s target
The unemployment rate of 5.8% in October is below the central tendency projections of the FOMC, which are at 5.9% – 6% in the fourth quarter of 2014. It is also close to the end of 2015 range of 5.4% – 5.6% and its long run projection of 5.2% – 5.5%. It is no wonder that Fed policymakers struck a positive tone in last month’s FOMC statement in which they ended the asset purchase programme. FOMC members pointed explicitly to “solid job gains and a lower unemployment rate” and noted that “underutilisation of labour resources is gradually diminishing”. This is an important shift since the more dovish FOMC members had often used ‘significant slack’ as an argument to maintain accommodative monetary policy. The labour market data makes a rate hike in June 2015 more likely, which is more or less what the FOMC members have been signalling. This is also in line with our forecast. However, financial markets are positioned for a later rate hike.