Backward-looking Strength, Forward-looking Angst

The labor market report for December was unambiguously strong, highlighting the conundrum the FOMC  faces in the first quarter of 2019. The market is worried about a slowdown in growth globally as well as in the U.S., and it is extremely skeptical of further rate hikes. The downturn in financial markets in response to these concerns represents a tightening of financial conditions that itself directly weighs on the outlook for growth. While the S&P 500, as well as the ten-year Treasury yield, have increased this morning, they remain well below levels seen just a few months ago, and the market gloom seems unlikely to lift anytime soon. On the other hand, the economic data in hand continue to point to a strong U.S. economy, on balance,  notwithstanding disappointments such as the December ISM print. (Chair Powell made this point this morning,  in a live interview alongside Yellen and Bernanke. We’ll follow up later today with a note on Powell’s remarks.) 

At this point, a March hike is a very close call. The FOMC’s priority is maintaining the expansion, particularly since inflation is so well contained, so the FOMC will be especially sensitive to signs of a slowdown in the incoming data. We already knew the U.S. economy was very strong in the second half of 2018, albeit with some soft spots. The December jobs report reinforces that story, but the big question is where the economy is headed. Thus, the incoming data are especially important for whether the FOMC raises rates in March.  While this is the last employment report before the January meeting, there will be two additional reports before the FOMC meets in March. 

Now for the specifics of the December jobs report. Nonfarm payrolls increased 312K in December, and upward revisions to previous months totaled 58K—significantly stronger than we assumed in our last forecast. Job growth was robust in the second half of 2018, with payrolls increasing an average of 222K per month. Other parts of the establishment survey data were also strong. Average hourly earnings posted a 0.40% gain, and the 12-month change edged up a tenth, to 3.2%. This supports the story that a tight labor market is putting upward pressure on wages. The increase in wages and payrolls, along with an uptick in the average workweek, corresponded to a solid increase in earnings in December. 

The household survey data showed that the unemployment rate increased two-tenths in December, to 3.9%.  This is no cause for concern at all, as it resulted from labor force growth outstripping employment growth.  The increase in the labor force corresponded to a two-tenths increase in the labor force participation rate. It wouldn’t be surprising to see a partial reversal of this increase in January. On balance, however, this jump suggests a bit more room to run in the labor market, and on the margin will help to alleviate concerns about labor market overheating. The labor force participation rate has been moving sideways for some time now,  with the strong labor market apparently pulling workers back into the labor force and offsetting the downward secular trend caused by demographics. At 63.1% in December, the labor force participation rate rose just outside the 62.7%-63.0% range it had been in since October 2017. It is striking how little the unemployment rate has declined over the past year even as real GDP has grown rapidly. Given that we anticipate a significant deceleration in real GDP growth this year relative to 2018, we see some upside risk to our forecast of a  decline in the unemployment rate to 3.4%.

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