The Jobs Machine Chugs Along

Expect modest employment gains in the July report, says Action Economics. But don't look for any letup in the Fed's concern about inflation

New month, same trend: We at Action Economics expect the July U.S. employment report, scheduled for release Aug. 4, to show a 140,000 rise in the headline nonfarm payrolls figure. This estimate is right in line with the 142,000 monthly average through the first half of the year.

We assume the report will reveal the now usual crosscurrents of restrained payroll growth, but steady gains in wages and strength in the household employment survey via a downtick in the unemployment rate. We arrived at our forecast by examining a number of factors:

Industry trends: A handful of industries have accounted for much of the shortfall in payrolls relative to expectations in recent months. The sharp slowdown in residential construction activity has resulted in a moderation in construction payroll growth, with gains of only 3,000 per month over the last four months compared with the 27,000 average over the previous two years.

Retail trade has fallen for three straight months, for a total of 86,000. The last time we saw a worse stretch was in March, 2003, when we saw three consecutive months of declines on commodity price gains related to Iraq War uncertainty, perhaps similar to the current period.

The bellwether "temp" employment series has dropped in four of the first six months of 2006. This is the worst stretch since late 2002. Given that the temp series is viewed as a leading indicator for broader employment trends—in light of the ease of hiring/firing workers—this may be sending a message of less job growth in the second-half of 2006.

Overall, a "bottom-up" forecast supports another gain in the neighborhood of 130,000 to 150,000.

The household survey: While the establishment survey (i.e., payrolls) has revealed growth of only 142,000 per month in the first six months of the year, the household measure of job growth—used to derive the unemployment rate—has shown average monthly job growth at a robust 264,000 pace. This has left the unemployment rate dropping to 4.6% in June, from 4.9% at the end of 2005. Given that the household survey is less subject to large benchmark revisions, the strength in this survey provides a noteworthy contrast to the restrained gains evident in the payroll survey.

Hourly earnings: Wage growth on a year-over-year basis has risen steadily since the start of 2004, and it appears that compensation costs this year have accelerated. Growth in both nominal earnings and real earnings are well up from the cycle trough, though strength in headline inflation used to deflate wages has prevented big gains in real earnings. Given the tight labor market and continued strength in various inflation measures, we expect a continued elevated trajectory for earnings. Despite restrained job growth, strong wage growth will remain an inflation concern for the Fed.

Forecasts and revisions: The average median forecast for payrolls over the last seven months was 198,000, compared with the average "as-reported" payroll figure of 156,000—leaving an average monthly shortfall of 42,000. Unlike most of 2005, when we saw a pattern for upward revisions to the "as-reported" figure, 2006 has revealed a pattern of net downward revisions. The current average for payroll growth over the last seven months is only 143,000—or an average of 55,000 less than the median forecast.

Forecasters appear to be trimming their projections to compensate for this lower trajectory as we head into the second half of the year. The median for July payrolls is 146,000, compared with the 212,000 average median forecast in the first quarter. Actual payroll growth has shown a similar slowdown, with average monthly payroll growth in the second quarter of 108,000 vs. the 176,000 average in the first.

Seasonal trends: Historically, July is second only to January for net job attrition, as summer schedules necessitate at least temporary job separations on a large scale. The last two years have revealed an average of 1,140,000 fewer jobs in July relative to June on a not seasonally adjusted basis. Given that most labor market indicators suggest a tight labor market, there is risk for less attrition than normal, as firms hesitate to let employees go in a tight market. This would suggest some upside risk to the reported seasonally adjusted figure.

Other job-market indicators: Initial jobless claims in July have revealed the usual swings related to auto-industry retooling, but have gyrated around a surprisingly lean level that is consistent with a continued tight labor market. The recent upswing in continuing claims, however, may indicate less downside pressure is emerging in the unemployment rate.

The current conditions series from the University of Michigan consumer-sentiment report and the Conference Board's consumer-confidence index that tends to be more dependent on labor market conditions. Both revealed surprising strength in July despite the expected headline effects of the crisis in the Middle East, high energy prices, interest-rate fears, and a falling stock market. This bodes well for the underlying health of the labor market.

The employment components from the factory-sentiment surveys have been mixed so far in July, implying risk of no big change on the month relative to recent trends.

The Help Wanted Advertising Index suggests some downside risk to payrolls, with the most recent June reading holding at 33. The usefulness of this survey is suspect, given the ongoing transition to use of the Internet for job postings. But the sharp deterioration in this series over the last four months, which has been evident in all nine regions, leaves the series at the lowest level since June, 1961.

The July Challenger job-cut survey fell to a six-year low of 37,200, which supports the tight labor market upside risk to the July employment report. Meanwhile, the ADP index showed private employment rose 99,000 in July, vs. 368,000 in June. That's right on top of our 100,000 estimate.

Of course, the Federal Reserve will carefully eye the July jobs numbers as the last major economic report before the central bank's Aug. 8 policy meeting. The market remains relatively comfortable with the notion that the Federal Open Market Committee is in pause mode after dovish Congressional testimony from Fed Chief Ben Bernanke and the soft initial read on second-quarter gross domestic product data. We revised our Fed outlook after the GDP data and now project a pause in August. The payroll figures for July will determine whether this assumption can be kept in place through meeting-time.

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