Payrolls recover in June, earnings conundrum continues

David Page, Senior Economist at AXA Investment Managers (AXA IM), discusses US payrolls data.

Key points

• Payrolls post a solid +222k, with a +47k revision to previous months.
• Unemployment pick up to 4.4%, driven by recovering labour supply and a rise in participation rate.
• Average earnings fail to accelerate, recording 2.5% in June.
• Federal Reserve (Fed) will take heart from strong momentum signalled in payrolls, but stable earnings growth will fan doves’ concerns.

Non-farm payrolls recorded a 222k gain in June, in excess of consensus forecasts for a 178k gain. The previous two months were revised up by a total of 47k, May’s weak 138k revised up to 152k. In total, the three-month payrolls average recorded a robust +193k in Q2, compared with Q1’s +166k. The Federal Open Market Committee (FOMC) minutes repeated that the pace of payroll gain was more than sufficient to absorb new labour entrants. The current pace is all the more so. Except in June it did not.

Unemployment increased in June to 4.4%, from 4.3% last month. As we noted at the time, the drop in May’s unemployment rate resulted from a sharp (0.3% m/m) contraction of the labour supply. This was unusual; we considered it erratic and anticipated a reversal. June recorded a 0.2% rise in labour supply, above the 0.1% we judge to be the medium-term rate, lifting the participation rate to 62.8%. This increase in labour supply (361k) exceeded the 245k increase in household survey employment and raised unemployment. June’s 4.4% remains below the lower estimate of the FOMC’s 4.5-4.8% range estimate for the longer-run rate of unemployment. We forecast a further increase in labour supply over the coming months, but do not envisage unemployment rising above 4.4% and forecast it falling to 4.3% around the turn of the year. Underemployment, as recorded by the broader U6 measure of unemployment, including involuntary part-time workers and those ‘marginally attached to the labour force’, rose to 8.6% from 8.4%, back to April’s rate.

Yet still earnings did not rise. June’s average earnings annual growth accelerated to 2.5% from a downward revised 2.4% in May (from 2.5%). Indeed the quarterly average annual wage growth slipped to 2.5% in Q2, the weakest quarterly average since Q1 2016. The usual uncertainties surround the relationship between resource utilisation and price pressure. This was a key theme in June’s FOMC discussions. One factor is productivity growth; while annual productivity growth picked up to 1.2% in Q4 2016 and Q1 2017, the combination of faster employment growth and more average hours worked in Q2, against our estimate of Q2 GDP growth of 2.4%, suggests the annual rate will soften again in Q2.

Today’s report takes the Fed little further forward in its consideration of future policy. Robust payrolls growth is a testimony to decent underlying economic momentum. The rise in the unemployment rate despite that underlines the limits of knowledge surrounding how low unemployment can go before it generates wage inflation. And in the meantime, the wage outlook continues to be benign. For now this will not change the FOMC’s course of action and we expect the Fed to announce its balance sheet unwind in September and lift the Fed Funds Rate one more time to 1.25-1.50% in December. We expect the labour market to exhibit more signs of tightening, including faster wage growth by year-end. As such, we forecast three hikes in 2018. If this does not materialise we think 2018 may find the FOMC doves in the ascendancy again.

-ENDS-