Improving Labor Market Without Wage Pressure

Another strong and above-consensus rise in payroll employment, combined with a two-tenths rise in participation, points to a still improving labor market, notwithstanding a one-tenth rise in the unemployment rate that left it still at the currently estimated NAIRU. The only downside in the report is the disappointing advance in average hourly earnings, but even that has a favorable implication; there still appears to run room in this labor market. We have viewed a decline in the unemployment rate as the most important potential driver of a March hike, especially if complemented by a sustained rise in wage growth. With little evidence of those developments, this report leaves intact our expectation that there will not be a hike in March, but there will still be three hikes this year. 

Payroll employment continues to surge, and yes, I think that’s an appropriate characterization. Payrolls increased 227K (vs. an expected 180K), with private payrolls up an impressive 237K, dramatically above the threshold needed for a stable unemployment rate. 

∙ Frankly, these gains are especially impressive for a labor market thought to be so close to full employment, with just modestly above-trend output growth, and with many firms claiming they cannot find workers with the skills needed for the respective jobs. 

∙ It is more than double the estimated threshold for maintaining a constant unemployment rate (roughly  80K to 100K), at least assuming a demographically driven secular decline in the participation rate. 

The combination of a one-tenth rise in the unemployment rate and a two-tenths rise in the participation rate points represents, in our view, a clear improvement in the labor market. 

∙ Of course, a one-tenth change in the unemployment report is appropriately characterized in the report as  “little changed.” 

∙ In any case, this report is music to the ears of those FOMC participants who believe there is still a “running” room, notwithstanding the low unemployment rate. 

∙ A rise in the participation rate goes to the heart of the benefits of a “hot” labor market, and achieving this outcome without signs of wage pressure reinforces the case for promoting, or at least accommodating, a somewhat lower unemployment rate, one that is modestly below the currently prevailing estimate of the NAIRU. It is nevertheless noteworthy that the rise in participation follows the pattern emphasized by Alan Krueger. It does not reflect people being drawn back into the labor force (usually the heart of the case for a hot labor market), but fewer unemployed workers leaving the labor force. 

∙ But workers staying in the labor force suggests increased confidence in finding a job, consistent with recent surveys. That’s very good! We still expect the secular decline in the participation rate to reassert itself, but perhaps only once employment growth falls from the stratosphere. 

The only disappointing part of the report was the below-consensus rise in average hourly earnings which left the 12-month rate at 2.5%, compared to the downwardly revised 2.8% from the previous month. ∙ We, however, downplay this measure because the Board staff has such a strong preference for the  

more comprehensive ECI measure. And that measure of labor compensation change has shown only faint signs of a pickup.

“Measures of labor market conditions.” 

∙ That’s the language in the FOMC statement about a wide range of measures of labor market utilization that the Committee considers. 

∙ Other than U-3 (the official measure of unemployment), we see the broader U-6 measure as standing out. From a cyclical perspective, it has not improved as much as U-3 and went up two-tenths in  January. 

Bottom Line: Strong employment growth, a rising participation rate, and a little-changed unemployment rate send a strong signal about the state of the labor market, especially with unemployment at (or virtually at)  the currently estimated NAIRU. To be sure, wage gains still appear muted. But the combination of strong employment gains with little wage pressure damps any urgency to raise rates. So our call remains no hike in  March, but still three hikes over the course of 2017.

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