Last Friday’s April Jobs report was clearly much weaker than expected. On average, analysts expected a payroll job gain of 1,000,000, with the unemployment rate falling from 6.0% to 5.8%. In the event, non-farm payrolls rose by just 266,000 and the unemployment rate rose to 6.1%.
However, the right way to look at Friday’s jobs report, as is the case of all jobs reports, is as one tile in a mosaic. In any mosaic, the individual tiles may be dull or colorful. But to see the true picture you have to step back and look at all the tiles together. Other data on the economy in general, and on employment in particular, are stronger than Friday’s numbers and the next jobs release, due out in the first week in June may well show both upward revisions to April and greater momentum in May.
The general picture of a fast recovery in the jobs market likely remains on track. Significantly, data due out this week will likely confirm that the demand for labor is growing faster than its supply and, crucially, this appears to be yielding steadily accelerating wage growth.
As strengthening wages are added to other price pressures, the likelihood of a significant pickup in inflation is growing. While the Fed seems determined to look through “transitory” increases in inflation, strong wage growth will make the “transitory” argument harder to maintain. As the pandemic ebbs, the economy strengthens, and wage growth accelerates, it seems likely that long-term interest rates will move up further, with significant implications for asset allocation.
Understanding The Jobs Miss
A job gain of 266,000 when analysts had been expecting 1,000,000 is, of course a huge miss.
But what’s behind it?
One element may just have been that a long series of blowout economic reports caused analysts to pad their own forecasts. March retail sales rose an extraordinary 9.8% when analysts had expected 6.1%. The Conference Board’s consumer confidence index soared to 121.7 in April compared to analyst expectations of 113.0. And housing starts for April came in at 1.739 million units in their strongest monthly performance since 2006, handily beating a consensus estimate of 1.613 million units. At a time when, because of pandemic effects, models are particularly unreliable, the temptation to be on the optimistic side was significant.
However, more scientifically, other indicators of the job market were very strong.
• In the Conference Board Survey for April, 37.9% of respondents described jobs as “plentiful” in their local area and only 13.2% said they were “hard to get.” That gap of 24.7 percentage points is higher than in the first half of 2018 when the U.S. unemployment rate was just 4.0%
• Initial claims for unemployment benefits were almost 100,000 lower per week in the five weeks leading up to the employment report survey week than in the prior four weeks and have now fallen below 500,000 per week.
• Layoff announcements compiled by Challenger, Gray and Christmas fell to less than 23,000 in April, their lowest reading since April of 2020, and,
• The ISM services employment index came in at 58.8 in April in its highest reading since September 2018.
These statistics are important not as a defense of bad forecasts but because they paint a fuller picture of the jobs market. Long experience also suggests that after an employment report misses on the downside, the report for the following month tends to show greater current strength and an upward revision to the prior disappointing report.
Beneath The Surface, Wages Are Still Accelerating
All of that being said, recent data also suggest that employment growth is being impeded by a lack of labor supply.
The job openings rate, which is measured as job openings as a percent of job openings plus total employment, hit an all-time record high of 4.9% at the end of February and this Tuesday’s JOLTS report could show a further increase in job openings at the end of March.
In confirmation of this, the April jobs report from the National Federation of Independent Business show 44% of small businesses having job openings they couldn’t fill, a record high in the 48 years in which they have been asking this question.
The modest payroll job gain in April, given the strength of the demand for labor, suggests that there are supply issues in the labor market.
One reason for this is collapsing immigration in the pandemic, which, based on immigration visas, may have fallen to just 150,000 people over the last year compared to over one million per year in the middle of the last decade.
However, another obvious issue is supplemental unemployment benefits. Regular state unemployment benefits averaged a very modest $318.25 over the past year. However, this is being supplemented by a further $300 per week in federal unemployment benefits through the first week in September. Because of this, on average, someone working a 40 hour week would need to earn better than $15.46 per hour to earn more than they would have done by being unemployed.
Over time, this might well have the impact of raising the wages for the lowest income workers as businesses just increase prices in labor-intensive industries. Many would argue that society would be better off if paying more for a hamburger or a room at a hotel provided better wages for low wageworkers. However, this is likely impeding job growth right now.
The Transitory Bet
Another impact of strong labor demand meeting limited labor supply should be accelerating wages—and this is occurring.
Seeing wage growth clearly is difficult because of the distortions caused by the pandemic. In brief, the pandemic resulted primarily in the layoff of low wageworkers, thus boosting year-over-year growth in average hourly earnings from 3.0% in February of 2020 to 8.2% by April 2020. Conversely, with almost two-thirds of the pandemic job loss now recovered, average hourly earnings were up just 0.3% year-over-year in April of this year.
However, if you adjust the data for the remaining shift in the sector share of aggregate hours and then look at wages on a year-over-two year basis, a very clear and startling pattern emerges as we show in our Weekly Market Recap this week. For years after the great financial crisis, wage growth was very stable at about 2% year-over-year or 4% on a year-over-two-year basis. In January 2015, wages were 4.1% higher than two years earlier. However, then they began to accelerate, with this measure climbing to 4.8% by January 2016, 5.2% by January 2017, 5.4% by January 2018, 6.0% by January 2019 and 6.6% by February 2020 just before the pandemic hit.
In April of 2021, this measure had climbed to 8.5% and, even using fixed sector shares of aggregate hours, wages would have been up 8.0% over the last two years.
This could ultimately be very important for Fed policy.
There are plenty of signs of rising inflation today and we expect Tuesday’s CPI report for April to feature a 3.5% year-over-year gain in prices—its strongest reading since 2011. The Federal Reserve is likely to argue that this increase and any further strength in inflation over the next year is just the transitory reflection of low base effects, pent-up demand from the pandemic and fiscal stimulus.
However, the evidence is clear that strong labor demand in the face of limited labor supply is gradually leading to an acceleration in wages. If this continues, then at least some of the inflation that the Fed now regards as transitory could turn out to be more permanent. As this becomes clearer, markets could well bid up long-term interest rates and pressure will likely build on the Federal Reserve to begin to taper bond purchases within the next year and to raise short-term interest rates within the next two years.
For investors, the jobs mosaic still suggests fast improving economic activity. However, this also still points to higher interest rates in the months ahead, which should be a positive for cyclical stocks and a challenge for long-duration bonds.
David Kelly is chief global strategist at JPMorgan Funds.