Labor Slack Shows Stocks Rely on the 'Yellen Put'
Optimists about the U.S. labor market have maintained that a healthy creation of jobs on a monthly basis and a falling unemployment rate pointed to approaching full employment. The expectation was for wages to accelerate, put upward pressure on inflation, and force the Federal Reserve to hike interest rates aggressively. In turn, that could precipitate a recession, ending the long-running rally in U.S. equities.
I have long held the opposite position -- that the labor market still has a lot of slack despite almost eight years of economic recovery from the recession. And inflation is not likely to accelerate any time soon. The jobless data for May, released June 2, provides ammunition to the position that the Fed and several Fed watchers have been wrong in adopting a hawkish stance.
The 138,000 jobs created last month fell far short of the 185,000 that the consensus had anticipated. In addition, job creation numbers for March and April were revised down by a combined 66,000, making for an even weaker job picture over the past three months. The financial media focused on the average annual hourly wage growth not accelerating, but slowing slightly, from 2.51 percent in April to 2.46 percent in May. But to understand the overall weakness of the jobs picture and its implication for investors, it is important to dig further.
First, the chart below shows that the average number of hours worked per week took a downward shift in early 2016, and has been stuck at around 34.4 hours, recording no growth over the past 14 months. This, combined with the slower growth in hourly wages last month, meant that weekly earnings suffered a double whammy -- not good for consumption spending, or for retailers’ earnings or stock prices. This is also not a signal of increasing bond yields.
The second long-term development that belies Fed statements of a tightening labor market is the falling labor force participation rate, both for the entire workforce (right scale, solid white line in the chart below), as well as for those in the prime working age group of 25 to 54 (left scale, dotted yellow line). Both were lower in May than they were in November 2007, the last month before the recession set in. In turn, this reduces the significance of the headline unemployment rate, U-3, falling from 4.4 percent in April to 4.3 percent in May. After all, having people leave the workforce is not an acceptable way to lower the unemployment rate.
Finally, not often discussed is the figure for the number of workers holding multiple jobs. About 7.6 million had more than one job last month, presumably because no single one was sufficient to pay a living wage. This was higher by 2.2 percent compared with May 2016, and remains above the figure at the end of the recession in mid-2009. Just as important, 5 percent of employed individuals held multiple jobs last month, up from 4.9 percent a year earlier. This also is a measure of the slack in the labor market -- you would expect to see fewer people, and a smaller percentage of employed workers, holding multiple jobs in a strong economic recovery.
There are three important messages for financial markets from the May jobs numbers:
First, if the Fed does decide to hike rates on June 14, despite the weak employment figures - - and it well may do so as Fed members have repeatedly prepared markets for a move -- the spread between the Treasury yield for two- and 10-year obligations is likely to narrow further. The spread already fell five basis points, to 87 basis points, on June 2. This is an important signal for investors that the economy is slowing.
Second, even if the Fed decides to tighten, it has to go back to the drawing board on how often it wants to increase rates at future meetings. Job creation and low and stable inflation are the Fed’s twin goals. If the labor market remains weak and inflation pressures continue to be benign, investors may be faced with a suddenly dovish Fed.
Third, while the yield on 10-year Treasuries fell June 2, and the spread on two- to 10-year Treasuries narrowed, U.S. equity averages hit new record highs following the jobs report. With equity valuations already elevated, investors have to decide which of the conflicting signals from the equity and bond market they wish to heed. As I argued in a recent article, the bond market has had a better record of predicting the last recession a year before it commenced.
While bonds are flashing yellow, equity holders may be too reliant on a “Yellen put” (a benevolent Fed) to bail them out. That could lead to a repeat of the errors of 2007 and 2008.
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