Comment on U.S. Labor Market Report, Inflation, and Fed Thinking

July 2, 2015

Growth in nonfarm payroll employment slowed in the first half of 2015.  The monthly average increase had been similar in the first and second halves of 2013 at 195K and 204K, respectively, and then accelerated to 239K in the first half of 2014 and 281K in the second half of last year.  Despite sub-300K readings in weekly new jobless claims, however, nonfarm payroll jobs in the first half of this year averaged 208K, in line with 2013 but not as good as the pace in 2014.

For U.S. inflation to return to the 2.0% target, one or a combination of three developments need to happen.

  • Commodity price pressures need to intensify in a broad way.  That’s not happening in an environment of subdued global demand.
  • The dollar needs to fall.  Instead, the currency has been strengthening, and flight to safety considerations point to a continuing upside dollar potential.
  • U.S. labor costs need to rise in a more sustained way.  Average hourly wages in June were unchanged on month and slowed to just 2.0% on year.

Among the above three factors, labor cost developments are most important.  In addition to the aforementioned slower pace of jobs growth this year, the broadest measure of unemployment, which includes underemployment, remains in double digits at 10.5%, labor force participation at 52.6% was actually lower than a year earlier, and the employment-to-population ratio was unchanged from a year before at 59.3%.  While a 5.3% unemployment rate and the weakness in labor productivity ought to foreshadow an upturn in wage inflation, the most telling barometer of how much slack in fact lingers lies in the average hourly earnings figures, which remain erratic from month to month but too low overall.

All this does not rule out a federal funds hike later this year and possibly at the end of the summer.  Fed officials appear to be increasingly antsy about the risks of prolonged zero interests and worried that such risks may mount exponentially from here the longer the first increase is delayed.  Ideally, central bank officials want to lead, not follow, the marketplace.  With long-term interest rates having already left the station, it’s already too late for the Fed to be the leader at this stage of the process.  The longer the first increase is delayed, however,  the more out of synch monetary policy will seem with the collective view of the market.  The wild card is Greece, but by September a great deal will not only be known about how the eurozone crisis is developing but also about its implications for countries not in Euroland or Europe for that matter.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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