Goldilocks rising: job market not too hot, not too cold

Jared Bernstein Posted by Jared Bernstein.

From 2009 to 2011, Bernstein was the Chief Economist and Economic Adviser to Vice President Joe Biden, executive director of the White House Task Force on the Middle Class, and a member of President Obama’s economic team.

Goldilocks rising: job market not too hot, not too cold

Source: BLS, my analysis

The pace of employment gains slowed slightly in August, as payrolls were up 151,000 and the unemployment rate held steady at 4.9 percent.

Despite the fact that expectations were for 180,000 jobs, the lower number in today’s report should not at all be taken as a change in the solid, underlying trend in employment growth. First, note the JB smoother figure below, which averages out the bips and bops in the monthly data by showing monthly gains at 3, 6, and 12-month averages. Over the past three, payrolls are up 232,000 per month on net, and while the six-month average gets dinged by May’s outlier 24,000 count, the longer term average is right about 200,000.

It is also the case, as I discuss below, that in recent years the first report of the August payroll number has later been revised up (perhaps due to seasonal adjustment issues).

But the broader picture suggests that, barring a negative shock, job gains of these magnitudes will continue nudging the US labor market towards full employment. However, while I put more weight on the smoothed values, the weaker-than-expected payroll number, along with a few other indicators in the report noted below, may give some of the more dovish Federal Reserve officials the evidence they need to hold off from a September rate hike, an outcome I would view as highly positive.

In fact, last night markets placed the probability of a September rate hike at 27 percent. This morning, post-jobs-report, it’s at 18 percent.

Other indicators which may dampen the “craze to raise:”

–The underemployment rate remains elevated at 9.7 percent, where it has been for four of the past five months. My analysis suggests that’s about a percentage point above the full-employment underemployment rate;

–Labor force participation remains low (the rate is stuck below 63 percent) and hasn’t moved much in recent months;

–The goods sector shed 24,000 jobs last month with small negatives in all major subcategories, including mining, construction, and manufacturing;

–Average weekly hours ticked down slightly;

–Year-over-year wage growth decelerated slightly from 2.7 percent in July to 2.4 percent in August.

–Health care employment, typically a stalwart, added only 14,000 jobs last month, well off its average pace of around 40,000.

I’m somewhat concerned about weaker job growth in the goods sector—the weakness in manufacturing and construction have persisted over the past year. And the underemployment/non-participation problem remains a clear signal that we’re not yet at full employment. But the downshift in payroll gains is no sign of a slowing in the underlying trend and, if anything, underscores (from the Fed’s perspective) the Goldilocks job market: not too hot, not too cold.

August’s seasonals: It’s worth remembering that these payroll numbers undergo numerous revisions as the BLS refines their initial estimate with more complete data. In advance of today’s report, numerous analysts have pointed out that in recent years, BLS has often revised up the first report of the August payroll gain. The figure below shows the revision from the first to the third release of the August payroll change. For example, in September 2007, the jobs report for August reported a loss of 4,000 jobs. By the time the third revision was in a few months later, that number had been revised up to 93,000, a revision of 97,000 (93K – (-4K)), as you see in the chart. The suspicion is that the first report is missing shifts in the timing of back-to-school hiring. So coming months may reveal that August’s gain was >150K.

Source: BLS

Source: BLS

How might the Fed read today’s report? With just two more employment reports before the November election, today’s report will certainly get thrown into the political mix, but even more consequential is how the members of the Federal Reserve Open Market Committee will read the numbers. Based on a robust set of challenging economic dynamics that have evolved in recent years, the Fed’s usual models and guideposts have proven less reliable of late. That’s made it hard for Fed watchers to understand their reaction function to reports like this one. No question, they’re close to another rate hike, and Chair Yellen has broadly signaled that unless there’s a notable hiccup in the data flow, an increase in their target rate could be on the table for their September meeting later this month.

How does today’s report fit into that mix? I’d guess it takes the probability of a September rate hike down to below 50 percent. A 200+K number would have sharpened the hawks’ talons; the 150K number releases the doves.

And then there’s inflation, the path of which provides the most compelling reason to chill.

Especially given the fog surrounding monetary policy right now—what’s the natural rate of unemployment?; what’s the neutral interest rate?; what’s the slope of the Phillips Curve (the correlation between unemployment and inflation)?—the smart, simple play is watch inflation, actual and expected. The latter appears well-anchored and the former (using PCE core) remains consistently below the Fed’s 2 percent target.

Researchers at Goldman Sachs (no link available) use a bottom-up model of inflation (i.e. modeling components of the core PCE) which does a good job of tracking the index. They forecast inflation to be 1.7 percent by the end of this year and 1.9 percent by the end of 2017. Assume they’re in the ballpark.

Now, consider that the 2 percent target is not a ceiling but an average. If GS is right, expecting a month or two here and there, the Fed will have missed their target to the downside for about eight years by the end of 2017. Not only is that a remarkably long period of dis-inflation (and evidence of the challenges facing contemporary monetary policy). Especially in light of today’s Goldilocks report, it’s a strong argument for not tapping the brakes, allowing the job market to continue tightening, and overshooting the inflation target for a time to hit the average.

Still, what damage will a 25 basis point in the target range really do? Perhaps not much, but here’s what worries me, succinctly put by Nobel laureate Mike Spence:

“But raising interest rates unilaterally carries serious risks, because in a demand-constrained environment, higher interest rates attract capital inflows, thereby driving up the exchange rate and undermining growth in the tradable part of the economy.”

And who needs that? (Spence suggest that if we must raise rates, we should consider capital controls to block the inflows. That’s a policy one associates much more with emerging economies protecting themselves from exchange rate volatility. But I’m hearing more people suggest it, as it falls out of the sort of analysis I offer here.)

So let’s hope the payroll number dampens the craze to raise, which seems motivated more by “hawk management” personnel policy at the FOMC then sound economic policy.