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Why I don't buy the 4.5% Unemployment Rate

Where is the wage pressure?

That's the question on my mind as we await today's NFP. Yesterday saw a stronger than expected ADP Report, which whacked bonds and sent yields back over the 5% level; The 10 year closed at 5.144%. A prime mover: growth in service industries, which accelerated to the fastest pace in 14 months in June.

The Fed will be closely watching the data for signs that Average Earnings are rising, as a gauge of potential inflation.

Which brings us back to our original point: If Unemployment is actually as low as its been reported by BLS, then there is no slack in the labor market. We have a situation where demand is outstripping supply. In the Oil market, that sends prices higher. In Agricultural commodities, the same thing occurs. Indeed, in every market I can think of, when Demand is greater than Supply, prices rise. That's Econ 101: prices should be rising robustly in that environment. 

Yet we see little evidence that wages and salaries are moving appreciably higher. Outside of bonuses and stock options, most wages have been pretty stagnant. For most of the past 4 years, they had been falling on a relative basis to inflation. Its only the past few quarters or so that hourly wages have risen at the rate of inflation or better.

A sign of a slack labor market is sluggish wage gains. Which is pretty much what we have been seeing.

The WSJ's Ahead of the Tape column looks at the same issue, and asks a different question:

The Federal Reserve says measures of inflation have improved lately. But it's still worried that there's little slack in the economy, which could ultimately push prices and interest rates higher. A key measure of slack is the unemployment rate. When it gets very low, it can be a signal of labor shortages that create wage and price pressures.

The labor market appears to have weakened a bit. Through May of this year, surveys of U.S. businesses show they added an average of 133,000 nonfarm jobs per month to their payrolls, according to the Labor Department, down from last year's average of 189,000.

Yet even though job growth has been slowing, the unemployment rate isn't budging. It is expected to come in at a relatively low 4.5% for June, around the level it's been at for nine months. This is all the more striking because the survey of households that the Labor Department uses to calculate the unemployment rate shows especially paltry employment gains through May this year. Those paltry gains suggest the unemployment rate should be rising.

His take is that since NFP gains have been on the low side, we should see unemployment tick up. My view is that all these Quarters of low unemployment should have sent wages skyrocketing, late 1990s style.

Yet neither has happened.  I cannot help but wonder why . . . 

>
Where's the wage pressure?

chart courtesy of economagic

~~~

A few other things to watch for:

1) ADP data showed private sector job creation of 150k. That is the number of total NFP the economy needs to merely keep up with population growth and immigration each month. Watch for a celebration of mere population growth.

2) The June number enjoys a healthy Birth Death adjustment.  Bill King noted that "Last June the BLS created 166,000 (175k Prelim) Net B/D Model jobs out of thin air."

>

UPDATE: July 6, 2007 8:39am

WSJ:

"Nonfarm payrolls increased 132,000 in June, after swelling 190,000 in May and 122,000 in April, the Labor Department said Friday. Previous reports showed job growth of just 157,000 in May and 80,000 in April. Monthly job growth has averaged a robust 145,000 so far this year. The unemployment rate was unchanged last month at 4.5%.

Average hourly earnings increased $0.06, or 0.3%, to $17.38. That was up 3.9% from a year earlier, suggesting tight labor markets still aren't putting much pressure on labor costs."

A few notable data points from the release:

• B/D Adjustment was +156k

• Education and health services were strong at +59k, as was Leisure and hospitality +39k and Government +40k

• Construction employment was up by 12,000  (WTF?)

• Professional and business services were down 9k

>

Sources:
ADP Employer Services Says U.S. Added 150,000 Jobs
Shobhana Chandra
Bloomberg, July 5 2007
http://www.bloomberg.com/apps/news?pid=20601087&sid=aQ.DttbnfLwQ&

Help Wanted: A Labor Report With Some Slack
Justin Lahart
WSJ, July 6, 2007; Page C1
http://online.wsj.com/article/SB118368257096758684.html

CES Net Birth/Death Model 
http://www.bls.gov/web/cesbd.htm

Employment Situation
http://www.bls.gov/news.release/empsit.toc.htm

Friday, July 06, 2007 | 07:13 AM | Permalink | Comments (50) | TrackBack (3)
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Comments

Don't have any idea of this will show the break or not, but August's BED will be very interesting either way. 0827 EST

Posted by: Eclectic | Jul 6, 2007 8:25:42 AM

Just a thought:

Isn't wage pressure created by employment mobility rather than mere employment? In other words, its not as important to get a job as it is to get the next job. There's no real easy way to measure people changing jobs, like there is to measure people getting jobs. Like I said, this is just a theory, but a large static workforce would seem to create as little wage pressure as a smaller workforce.

Also, some would say you're looking at the wrong measure. Rather than wages, you should be looking at total compensation.

Posted by: Ted Craig | Jul 6, 2007 8:29:41 AM

June Payrolls are expected to rise by 125k vs a 157k gain in May. The average ytd gain in payrolls is 133k vs 189k in '06. Even though the monthly #'s haven't shown much correlation to the ADP data on any given month, yesterday's better ADP # has led to whispers of a higher # today. The unemployment rate is expected to remain unch at 4.5% and avg hourly earnings are expected to rise .3%. Due to general expectations in corporate America of a 2nd half economic recovery, companies have been very reluctant to trim staff in light of the moderating economy at the 2%ish level over the past year but it's also the reason why job growth is running below last year's level. Bonds are little changed ahead of the data as is the $. Refinery concerns and Nigerian supply disruptions sending crude higher again.

Posted by: Peter | Jul 6, 2007 8:30:15 AM

I've been reading your blog for a while. I have to say that I think the Fed and the government understand exactly what is really going on with inflation -- but they have a vested interest in publishing a much lower number. Since social security payments are linked to the cost of living, admitting what is really going on would be hugely expensive for the government, and at least this administration does not appear inclined to give away the treasury this way -- they prefer to reallocate funds to the upper incomes and let some of it reinvest in the economy instead of on saving and consumer spending. For better or for worse.

Posted by: Neil Harris | Jul 6, 2007 8:47:11 AM

Like other commodities, substitution can help keep prices down. It may be that as wage pressure increases, so does outsourcing activity, thus reducing wage pressure... Also, I don't believe people are over the otsourcing shock, and the psychological blows of constantly reading about large layoffs somewhere in America may be keeping folks a bit less demanding of higher wages....Both points pure speculation...

Posted by: Quints | Jul 6, 2007 8:47:52 AM

In my field, pharmaceuticals, hiring hasn't been strong in years. Big downsizings at Bayer, Pfizer, Biogen, etc. I think many people have taken early retirement or are working low level jobs to get by.

Posted by: Tom B | Jul 6, 2007 8:56:33 AM

According to the report, wages are up 3.9% from this time last year... Thats certainly above inflation(roughly 2.6~2.7%) and shows modest wage growth.

What numbers are you looking at that show real wages going down? All the numbers I see indicate modest wage growth after inflation(year over year that is).

~~~

BR: If you think inflation is running at 2.6%, there's little I can inform you about wages, income, unemployment or other govt data . . .

Posted by: John | Jul 6, 2007 9:08:30 AM

Barry,

I believe a partial explanation lies in 2 things -- productivity and the self employed entrepreneur. Productivity has made fewer workers necessary, and workers that leave jobs many times start their own businesses.

Food for thought.

Posted by: Fred | Jul 6, 2007 9:19:59 AM

Barry, are you saying that if food and fuel were added into the inflation reading that it would be much higher than 2.6%?

Posted by: Woodshedder | Jul 6, 2007 9:21:03 AM

I don't find wage stagnation a great mystery when you read...

"New hiring in the areas of education, health services, leisure and hospitality and government drove overall job growth last month. Construction companies also expanded employment — even as they coped with fallout from the housing slump. Those employment gains swamped job cuts at factories, retailers and certain professional and business services."

It's not numbers of jobs but quality of jobs that matters. Teachers, health care workers, and government employess have no great sway in forcing higher wages - they added jobs.

Unions, such as in manufacturing, have power to increase wages - they lost jobs.

I think we took the wrong exit when we hit the Phillips curve.

Posted by: Winston Munn | Jul 6, 2007 9:26:52 AM

"With housing starts off over 30%, it's a puzzle why residential construction employment is only off about 4%." It's been solidly demonstrated that the birth/death model is vastly overstating jobs. When the BED is updated to this quarter-currently completed for Q3 '06, we'll find that 95% of the jobs gained from that model were ghosts....just like Q3 '06. The unemployment rate of 4.5%...give us a royal break. It's designed not to count you as unemployed. Leaves out discouraged workers who gave up looking, we'll just leave them out...don't want to make the statistics look too bad. Working 15 hour weeks with NO pay...hey no problem, we'll count you too as employed-we know you want to be. Get arrested while having a job, no problem, still counts those jobs. Your unemployment benefits ran out last week after 20 weeks, ok, now we assume you must be employed.... anyone would have to be a fool to believe those figures. Economic figures are as much political figures.

Posted by: stuart | Jul 6, 2007 9:28:21 AM

You can't compare the headline number to that of the birth/death model as the headline number is seasonally adjusted and the birth/death model is not. the correct comparison is the non-seasonally adjusted employment numbers to the birth/death model which for the months of April, May, and June were:

Employment: 856k, 941k, 504k
Birth/Death: 317k, 203k, 156k

It doesn't look quite as bad when you look at it on an apples to apples basis.

Posted by: some guy | Jul 6, 2007 9:32:53 AM

Barry,

According to your June 15 post...

"There can be little doubt that consumer inflation -- up 2.7% year-over-year -- is slowing with the economy. The core CPI remains elevated at 2.2% year-over-year -- slightly above the Fed's comfort zone of 2.0%."

Even when food and energy prices are included inflation is 2.7%. Over the last four years CPI is up an annual rate of 3.15%. Food is up 3.1%, energy is up 12.9%.

I can understand not believing the core 2.2%, but how does inflation get at or above 3.9%?

Posted by: John | Jul 6, 2007 9:34:34 AM

There are a couple of things going on which could cause the discrepancy you are seeing:

1) Composition adjustment. The mix of workers as well as the relative demand and supply of workers determines average earnings.

For example, even a slack market in I-bankers is going to have higher wages than a tight market for cashiers.

This is actually a big deal. Not to go to nerdy on you but economy wide productivity gains fall significantly below industry by industry gains because high productivity industries tend to shed workers. Not always of course, but that is the general tendency.

So, as we shed production jobs and pick up low skill service jobs we could actually see wages fall.

2) Size of the labor force. The labor force is growing at a much slower rate than it did in the mid-90s meaning that an inequivalent unemployment rate implies slower job growth.

There is no reason to expect that the boost in the labor force we had in the 90s will ever return. It was probably a one time phenomenon that had to do with the confluence of a lot of social and technological factors.

It could happen again but even the best monetary policy can't be expected to reproduce that experience.

3) The natural rate could be falling. Depending on your theory of the natural rate there is reason to believe that it is falling. If you believe that the service-sector-natural-rate is lower than the production-sector-natural-rate then you might expect the natural rate to continue to fall as US manufacturing declines in employment.

Also, there is a nerdier argument that before the 1990s the US was too large to be effectively supported by a single currency. Increasing in digital technology and decreases in transportation cost have knit the US economy together more firmly and led to a decrease in the natural rate.

Posted by: Karl Smith | Jul 6, 2007 9:55:30 AM

Moin,

interesting to see that the greenback is selling off despite the "strong" job number.....

Posted by: jmf | Jul 6, 2007 10:16:48 AM

Can I just remind everyone that the Secretary of Labor is married to the Senate (Republican) Minority Leader.

Posted by: bam | Jul 6, 2007 10:42:01 AM

I'd like to point out a possible broadening out of job gains -- quoting Tony Crescenzi:

"An interesting aspect of today's payroll report is a gauge that tells us the percentage of industries that added workers during the month: the diffusion index. In June, it was very high at 62.9% among the 278 industries surveyed."

As he says, it's only one month's number, but if it's a trend, could be good

Posted by: Fred | Jul 6, 2007 10:42:15 AM

Zandy from economy.com has opined that CPI measures are meant for rich folks lifestyle (net worth 5mil+). For them, inflation is low.
in capitalism, after all, policies have to made that best suit the capitalists.

Posted by: sam | Jul 6, 2007 10:51:35 AM

This is a question for Barry or the sharp commenters, if we agree that the inflation ex-inflation numbers are a joke because they exclude gas, housing, etc., when will we see true inflation drop due to reducing home prices? I know that the real estate bubble has been worse on the Coasts, around Vegas & in Florida, but will not the reductions in home prices help cool the jets on true inflation nationwide?

Posted by: Matt | Jul 6, 2007 11:08:37 AM

Construction employment was up by 12,000 (WTF?)

LOL! We ain't building the Space Shuttle folks. ILLEGAL ALIENS! Don't expect we will hear this mentioned by anyone but Lou Dobbs and Bloggers like Barry.

All I can say is that the elites take us for fools, and based on this mornings action in the market and bonds, I guess they are as right as rain.

Let me get this straight. Bonds are up [yield] because the market believes the numbers were hot? ROFLMAO! How about the fact that we compete for money on a global field, and everyone else is raising rates?

This isn't so much about an overheating economy, but rather, a recogniition that we must take the Treasury Bonds to auction where the powers that be [China, Japan] decide how much we will pay in interest.

Posted by: SPECTRE of Deflation | Jul 6, 2007 11:10:19 AM

Ted Craig said: "Isn't wage pressure created by employment mobility rather than mere employment? In other words, its not as important to get a job as it is to get the next job. There's no real easy way to measure people changing jobs, like there is to measure people getting jobs. Like I said, this is just a theory, but a large static workforce would seem to create as little wage pressure as a smaller workforce."

This is something I'm waiting to see shake out politically. When all of these homeowners who bought in the last 3 years realize that they are not going to be able to move any time in the next 15 years, what are they going to start saying to their state and federal congrescritters and the courts? (If freedom of movement is a Constitutional right, and the government has been consciously providing false data that induced their accepting the over-inflated prices/abusive mortgages, I can see a new legal industry taking a shot at this.)

Posted by: XON | Jul 6, 2007 11:12:19 AM

BAM_

Yes most are unaware of that fact.

recall when Ms. Chao was a frequent guest on B'Berg and Suzy Assad just ripped her to shreds on the BLS numbers each month. The last appearance I saw was the customary bulldog Suzy attack (coupled with the correct amount of rhetoric that blasted the labor department's continued use of moving averages (explains why they think construction has added jobs) and she just sat there and said "well those are right because they are issued by the labor department".....before the mic was turned off "Ms. Chao" commented that her and her husband would never frequent this show again. "I'm taking my sandbox away and none of you can play in it until you kiss my ass"

I also have not seen Suzy for a while too-LOL

Ciao
MS

Posted by: michael schumacher | Jul 6, 2007 11:14:55 AM

I am entertained by the number of benign explanations offered ...

Posted by: David | Jul 6, 2007 11:19:02 AM

Concerning inflation, wouldn't a truer picture emerge by looking at a simple nickel. It costs the Mint 9.3 cents to make a damn nickel. There is your inflation folks, and the government numbers be damned because they have done so many contortions to come up with their FAKE numbers that it is now laughable. Core inflation? Excluding fuel and food? How about Healthcare and Education?

Concerning the employment numbers, but for the B/D adjustment, we would have had a negative number. Case closed already!

Posted by: SPECTRE of Deflation | Jul 6, 2007 11:22:45 AM

I am entertained by the number of benign explanations offered ...

I have spilled the coffee 3 times this morning laughing at this Alice In Wonderland extravaganza we call the markets.
We have definitely gone down the rabbit hole.

Posted by: SPECTRE of Deflation | Jul 6, 2007 11:29:47 AM

December 2008

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