Is The Market Still Laboring Under A Misconception About The Labor Market?

The short answer: Maybe not.

For the past several years, we have highlighted the potential disconnect between financial market participants and the Federal Reserve (Fed) when it comes to the labor market. The idea was that if the financial markets saw job growth decelerate from the 225,000 to 250,000 per month range seen from mid-2014 through mid-2015, it would assume:

  1. the labor market was no longer tightening,
  2. that the Fed would see this and not raise rates, and in the worst case,
  3. that the economy was headed for a recession.

Let’s look at the data and see what happened.

We made the case in early 2016 that we thought job creation would decelerate as 2016 unfolded, but that the labor market would continue to tighten, pushing up wages, and that the Fed would raise rates. Data released by Bureau of Labor Statistics (BLS) earlier this morning support that view, although we thought job growth in 2016 would slow even more than it actually did.

From early 2010—when the US economy began regularly creating jobs again after the end of the Great Recession in mid-2009—through the end of 2016, the U.S. economy created 15.6 million net new jobs, or an average of 188,000 per month. In 2015, job creation averaged 230,000 per month. In 2016, job growth averaged “only” 180,000 per month. Taking a closer look at 2016, monthly job creation averaged 200,000 per month in the first quarter of 2016 and slowed to just 165,000 per month in the final quarter of the year. So job growth did slow in 2016, the labor market tightened (more below), the Fed raised rates, and the economy didn’t go into recession. Indeed the Fed has made it clear in recent communications including the minutes of the December 13-14, 2016 FOMC meeting that most FOMC members think the labor market is closing in on full employment. Indeed, Fed officials have said publicly that job growth as low as 80,000 per month is enough to tighten the labor market and push up wages, and ultimately inflation.

While the labor market has tightened (please see the Employment Progress Market on pgs. 8-9 of our Outlook 2017), one notable exception is wage growth, but that may be changing, and in turn, helping to convince market participants who have been skeptical that decelerating job growth can still foster a tighter labor market and rising wages.

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Prior to the Great Recession, wage growth (as measured by the year-over-year increase in average hourly earnings) ran well above 4%. Wage growth cratered to just 1.34% in late 2012 (labor market data always trails changes in economic activity) and has been slowly moving higher since then, but has not even come close to the pre-Great Recession pace of over 4%. The latest (December 2016) reading on wage growth was 2.9%, the highest since April 2009, and further acceleration in this metric and other key measures of wages may finally help to resolve the disconnect between the market and the Fed on the labor market.

IMPORTANT DISCLOSURES

The economic forecasts set forth in the presentation may not develop as predicted.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.

The Federal Open Market Committee (FOMC) is the branch of the Federal Reserve Board that determines the direction of monetary policy. The eleven-person FOMC is composed of the seven-member board of governors, and the five Federal Reserve Bank presidents. The president of the Federal Reserve Bank of New York serves continuously, while the presidents of the other regional Federal Reserve Banks rotate their service in one-year terms.

This research material has been prepared by LPL Financial LLC.

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