Article / 07 June 2016 at 13:00 GMT

Despite dismal jobs print, US remains largely on course: Yellen

Managing Partner / Spotlight Group
United Kingdom
  • Yellen maintains largely favourable outlook for US economy
  • Labour force participation declines remain a pressing issue
  • 'This is no time for the Fed to pursue policy pedantry'

Philadelphia City Hall
Fed chair Janet Yellen's speech in Philadelphia addressed last Friday's dismal jobs report, but also noted the US economy's real progress towards central bank objectives. Photo: iStock

By Stephen Pope

Federal Reserve chair Janet Yellen spoke yesterday at the World Affairs Council of Philadelphia, and said that the outlook for the US economy is largely favourable having registered considerable progress toward the Fed’s twin objectives of full employment and price stability. 

Let me consider these two aspects of the US economy in turn, as each objective is closely linked to the Federal Funds Rate.

The labour market

The chart below shows that the news from the labour market over the past six years has been generally encouraging as the monthly level of the unemployment rate has fallen to 4.7%… a tremendous reduction from 10.0% in October 2009. 

Similarly, nonfarm payrolls have recovered substantially since falling by 823,000 in March 2009, although they are rotating in a shallow, horizontal channel.

On that note, the Fed Chair did acknowledge that the May 2016 increase at just 38,000 was the worst reading in five years and that the pace of average hourly earnings has not accelerated aggressively, just breaking over 0.4% on seven occasions in the past decade.
US Labour
Source: Bureau of Labor Statistics
US Avg H Egs Source: Bureau of Labor Statistics

Yellen was quick to point to several clear historical facts in that the economy has added approximately 2.7 million new jobs during 2015 at an average rate of 225,000 a month. During Q1 2016, nonfarm payrolls grew at a still-impressive average of 200,000/month and the level of unemployment settled near to 5%.

The Bureau of Labor Statistics' measure of the “job openings rate” had reached a record high in March and the “quits rate”, i.e. employees voluntarily leaving their jobs, moved up and in March was very close to its pre-recession levels.

So when taken in context, the May 2016 data reported last Friday were extremely disappointing. In fact, economists who have questioned the depth of the US recovery suggested the unemployment rate was only at 4.7%, i.e. down 0.3% from April because fewer people were actively seeking work. 

Nonfarm payrolls
The May nonfarm payrolls release was more than a blip, but a single report is not enough to force the Fed to abandon its normalisation plans. Photo: iStock 

The Labor Force Participation Rate in the US decreased to 62.6% in May from 62.8% in April of 2016, the lowest reading since December 2015.

Still, Yellen was not going to be too downcast and she readily pointed to the fact that it would be unwise to set too much store in a single monthly report. Other significant indicators from the employment market were more upbeat. The number of people filing new claims for unemployment insurance, as an example, remains quite low.

In the week ending May 28, the advance figure for seasonally adjusted initial claims was 267,000, a decrease of 1,000 from the previous week's unrevised level of 268,000. The four-week moving average was 276,750, a decrease of 1,750 from the previous week's unrevised average of 278,500. 

There were no special factors impacting this week's initial claims and this marks 65 consecutive weeks of initial claims below 300,000, the longest streak since 1973.

Price stability and productivity 

Consumer price inflation (CPI) in the US increased by 1.1% (year-over-year) in April 2016, higher than the 0.9% rise in the previous month and in line with market expectations. 

The monthly index rose 0.4%, the biggest such move in three years.

US inflation

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Source: Bureau of Labor Statistics

After the March 16 Federal Open Market Committee meeting, the Fed released what can only be described as moderate inflation forecasts. However, core inflation has been showing signs of accelerating over Q1 and could increase further in the second half of the year.

Looking at the path of commodity prices, i.e. the decline and now the current bounce, it is important to distinguish between measures of headline and core inflation. If oil prices stabilise at current levels, then inflation will automatically accelerate in the coming months and could well temporarily exceed the Fed’s 2% target.

Now that alone would not disturb Yellen and her colleagues at the Fed, but if wage growth were to break the 0.4% barrier on a consistent basis, then the challenge facing the Fed would be how to manage inflation expectations. Yellen may sound relaxed but she has to find an approach that will not jeopardise the objective of price stability. She needs to find the right timing and magnitude for future Fed Funds rate hikes so as to anchor inflationary expectations, which are currently complacently low.

Core inflation increased 2.1% in April of 2016 over the same month in the previous year and we can no longer point to real estate (33% of the index) as the only significant positive contributor. Core CPI is at levels not seen 2008/9 and other key components such as medical services costs have started to increase as well.

US industrial capacity utilisation increased to 75.4% in April from 74.9% in March and although shy of the high 70s seen at the end of 2014, capacity is being reabsorbed. The estimates of the US output gap suggest that the economy is approaching full capacity in 2016/2017 given demographics, slower productivity gains, ageing infrastructures, and income distribution issues. 

None of these issues have been addressed properly by the political classes as the 2016 election cycle has been running since mid-2015.

Unit labour costs are forecast by the Amundi World Investment Forum to accelerate in 2016 as the economy is on a fast track to full employment and labour productivity gains have dropped. Productivity gains have increased on average by 0.5% in the last five years, the slowest pace since 1982.

The pressure is on the Yellen Fed, and unless the June employment data set is as soft as May, I fully expect the Fed to move on Fed Funds taking the rate to 0.75% on July 27. This will be no time for the Fed to become pursue policy pedantry.

Interest rates
The path may be perilous, but the Fed remains willing to hike. Photo: iStock

— Edited by Michael McKenna

Stephen Pope is managing partner at Spotlight Ideas


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