- The December nonfarm payrolls report showed solid gains of 252K after a revised 353K the previous month. The unemployment rate declined to 5.6% down from 5.8% which is below the Fed’s end of year forecast. This report adds to other strong data, including robust GDP growth in the third quarter and solid November industrial production and retail sales.
- We expect that in 2015 economic activity will continue to increase at a pace sufficient to lead to further improvements in labour market conditions. As the Fed’s approaches its objective of maximum employment, we think that the Fed policymakers will hike rates by mid 2015.
2014 strongest year of job growth in 15 years
Decembers’ employment report confirms the solid recovery of the labour market. Nonfarm payrolls showed broad gains of 252K after a revised 353K the previous month. The unemployment rate declined to 5.6% down from 5.8% which is below the Fed’s end-of-year forecast. But some of the decline reflected people leaving the labour market. In 2014 the momentum in the labour market has been picking up steadily. Nonfarm payrolls showed solid gains (a cumulative change of 2.9 million) the strongest in 15 years. The unemployment rate declined by 1.1 ppts in 2014 to 5.6. Positive signs were also seen in the decline of the share of workers employed part time for economic reasons, which declined to 11.2% in 2014 down from 13.1% the previous year. Looking at the details the service providing sector saw strong gains in employment, particularly health and professional services. But other sectors which were weaker, including construction and manufacturing, also showed signs of improvement.
December’s wage growth tepid…,
Despite steady hiring, average hourly earnings were weak declining by 0.2% mom (1.7% yoy) after increasing 0.2% (1.9% yoy) the previous month. Until recently, there has been a relative weakness of average hourly earnings compared to the strength of labour market indicators. For Fed Chair Janet Yellen, the sluggishness in wage growth is partly explained by pent-up wage deflation. This suggests that many firms were unable or unwilling to lower compensation during the recession and the earlier part of the recovery and now they find they cannot yet raise wages.
…but don’t give up on wages
Other wage measures show signs of recovery. The employment cost index (ECI), which is more appropriate for forecasting future wage inflation, has shown the fastest increase in the past few months since the Great Recession. Still, growth rates remain modest. For some, the slow pace of increases is already evidence of diminishing labour market slack. Our forecasts indicate that unemployment will continue to decline this year from 5.8% to around 5% at year-end. The Fed expects unemployment to reach around 5.2% at the end of this year, approaching the normal long-term unemployment rate. Moreover, surveys of small businesses suggest that they plan to increase compensation in the coming months.
Fed officials remain optimistic on labour market
In the FOMC minutes released in January, Fed officials agreed that labour market conditions improved further, with solid job gains and a lower unemployment rate and judged that the underutilization of labour resources was continuing to diminish. Since October, the unemployment rate (now at 5.6%) has been below the central tendency projections of the FOMC, which are at 5.8% in the fourth quarter of 2014. Fed policymakers have noted that the lower energy prices and stronger dollar are likely to keep inflation below target for some time, but that this should not be an impediment to normalising interest rates. We expect a tighter labour market will prompt the Fed to hike rates in mid 2015 even if wage gains will by then only have had a small impact on price inflation.