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SIMPLY ECONOMICS

Labor surge and the elusive wage-inflation flashpoint
Simply Economics - March 9, 2018
By Mark Pender, Senior Editor

  

Introduction

Labor is in heavy demand but what nascent indication of wage inflation that had been appearing may now have vanished. Does this mean that 4.1 percent unemployment, a rate just recently thought to be far in excess of full employment, is not full employment at all? If so, then businesses can continue to find candidates to meet their rising order books and with this, corporate profits can climb without being syphoned off by increasing wages. If not, however, if candidates are in fact about to grow scarce and if employers begin to raise their offers, wages could begin to move higher and fast.


 

The economy

Nonfarm payrolls rose an outsized 313,000 in February to beat Econoday's high estimate by more than 80,000. The month's gain is one of the very largest of the post-2009 expansion in strength underscored by upward revisions to prior months totaling 54,000. Demand for professional and business services was especially strong in February with the temporary help subcomponent spiking 27,000 in a tangible indication that employers may now be scrambling to fill positions as quickly as they can and however they can. Retail also showed strength, up 50,000 in February, as did government with a payroll gain of 26,000. The gains failed to lower the unemployment rate as discouraged workers came back in force and were quickly absorbed, lifting the labor force participation rate by a sharp 3 tenths to 67.0 percent which matches its best reading of the last four years.


 

Despite all this strength, the monthly increase in average hourly earnings actually came in below expectations at only 0.15 percent (going out two decimal places is common for monthly inflation data). The trendline in the graph is flat with the average monthly gain over the last year at 0.22 percent. February's result, judging by Friday's stock-market reaction, seems to have made a distant memory of the uncomfortable gains of 0.38 percent in December and 0.45 percent in September or even the 0.26 percent result of January.


 

But it wasn't the monthly gain that caused all the fuss back in January it was the year-on-year rate, at a 2.9 percent initial reading which triggered the massive wobble in the stock market. In February this rate came in very soft, 3 tenths below the consensus at 2.6 percent with January revised 1 tenth lower to a less intense 2.8 percent. The graph compares the blue line of this rate against the green line of the Federal Reserve's central inflation target, the core PCE price index which has been struggling back toward the Fed's 2 percent goal. Indications of what to expect for the green line in February will be part of the coming week's economic data, specifically the core CPI price index on Tuesday.


 

Turning back to payrolls, the real meat of the gains came from two sectors where employment momentum is building. The year-on-year dollar increase for construction spending may only be 3.2 percent but construction jobs are now surging, at 7.2 million as tracked in the green line for a standout 61,000 February increase. Construction payrolls brushed the 8 million line back in the heyday of the sub-prime housing bubble but the current ascent back toward this high looks more and more convincing. Strength is also clear in manufacturing payrolls, at 12.6 million for a 31,000 monthly gain which is the fifth straight solid increase and consistent with the 6.7 percent yearly gain underway in factory orders. Note that 20 years ago, manufacturing payrolls were near 18 million in a level that, given decades of offshoring, looks like an historical artifact.


 

Lack of manufacturing jobs is a structural weakness of the U.S. economy as is the persistent trade deficit. The week's other economic headlines come from international trade where the gap deepened to a record $56.6 billion in what is the worst monthly showing of the expansion. A sharp 1.3 percent drop in January exports, to $200.9 billion, was behind the trouble. Exports of services were steady at $66.7 billion but exports of goods fell 2.2 percent to $134.2 billion. And here to blame were industrial supplies, which includes primary metals, down $1.3 billion to $41.5 billion and also capital goods, a central focus of U.S. strength that fell $2.6 billion to $44.9 billion and included a $1.8 billion decline in civilian aircraft exports to $3.8 billion. Imports, unchanged at $257.5 billion, showed increases for industrial supplies and petroleum but also a welcome downtick in consumer goods which, however, remain the Achilles Heel of GDP at $54.6 billion. Exports are going to have to pick up in February and March otherwise first-quarter GDP, however much payrolls may rise, will be fighting an uphill battle against an accelerating trade deficit.


 

Other data in the week included the ISM non-manufacturing report whose sample is once again reporting robust conditions, strength however that has yet to be matched by the "modest-to-moderate" description which the Federal Reserve's Beige Book keeps repeating. Yet the ISM's non-manufacturing employment index is proving itself true, trending higher as tracked in the dotted blue line of the graph and anticipating the pitch of the dotted green line which is the Labor Department's total payrolls less manufacturing. Judging by these two trendlines, payroll gains look to get bigger and bigger which of course would mean more and more bad nerves at the Fed.


 

Markets: What rate hikes?

The stock market turned sharply higher in reaction to the employment report and its combination of rising payrolls and easing wage pressures. Friday's 1.8 percent gain for the Dow offers a mirror image of the huge selloff that began after the January employment report showed a significant rise in wage pressures and awakened expectations for a fourth Federal Reserve rate hike this year. Rarely do economic readings -- in this case average hourly earnings -- create such visible and specific reactions in the market. But other markets showed less reaction especially Treasuries which are also super sensitive to economic data and where the absence of movement hints at less certainty whether the Fed will in fact stay pat at three hikes.


 

Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2017 2-Mar-18 9-Mar-18 Change Change
DJIA 24,719.22 24,538.06 25,335.74 2.5% 3.3%
S&P 500 2,673.61 2,691.25 2,786.57 4.2% 3.5%
Nasdaq Composite 6,903.39 7,257.87 7,560.81 9.5% 4.2%
     
Crude Oil, WTI ($/barrel) $60.15 $61.46 $62.06 3.2% 1.0%
Gold (COMEX) ($/ounce) $1,305.50 $1,322.00 $1,323.00 1.3% 0.1%
Fed Funds Target 1.25 to 1.50% 1.25 to 1.50% 1.25 to 1.50% 0 bp 0 bp
2-Year Treasury Yield 1.89% 2.24% 2.27% 38 bp 3 bp
10-Year Treasury Yield 2.41% 2.86% 2.90% 49 bp 4 bp
Dollar Index 92.29 89.96 90.13 -2.3% 0.2%

 

The bottom line

Policy makers at the Fed can afford to be a little patient given that overall inflation rates have remained subdued. But the gains in hiring are prodigious and are coming after a long run of economic expansion, meaning that the availability of labor, including highly qualified labor, is likely to be increasingly limited especially if fiscal stimulus begins to accelerate demand. If indications on wages begin to move higher, it would not be unreasonable to expect the markets, as they did back in January, to begin adjusting once again to less gradual monetary policy.


 

Week of March 12 to March 16

Inflation will be the week's special focus beginning on Tuesday with the consumer price report where any pressures at the core level could retrigger market concerns for a fourth rate hike this year. Keeping the inflation focus will be two reports that have shown increasing traction: producer prices on Wednesday followed on Thursday by import and export prices. The week's data get rolling on Monday with the Treasury statement for February where attention will be on both individual and corporate receipts and the unfolding effects of this year's tax cut. Consumer spending has been soft in recent months and February's retail sales report, where strength is the call, will be Wednesday's highlight. The week ends with key data on the housing sector, starts and permits, and also on the factory sector and whether the manufacturing component of the industrial production will finally show some life.


 

Monday


 

Treasury Budget for February

Consensus Forecast: -$216.0 billion

Consensus Range: -$230.0 billion to -$200.0 billion


 

The Treasury budget for February will offer early indications on the effects of this year's tax cut. The Econoday consensus is calling for a monthly deficit of $216.0 billion.


 

Tuesday


 

Small Business Optimism Index for February

Consensus Forecast: 107.1

Consensus Range: 105.5 to 107.6


 

Forecasters are calling for further acceleration in the small business optimism index which rose sharply in January on strength in earnings trends and optimism over expansion plans. Econoday's call for February is 107.1 vs January's 106.9.


 

Consumer Price Index for February

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.1% to 0.4%


 

Consumer Price Index

Consensus Forecast, Year-on-Year Change: 2.2%

Consensus Range: 2.1% to 2.3%


 

CPI Core, Less Food & Energy

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.1% to 0.3%


 

CPI Core, Less Food & Energy

Consensus Forecast, Year-on-Year Change: 1.9%

Consensus Range: 1.8% to 2.0%


 

Indications of price pressures for wholesalers and importers have yet to appear in force in consumer prices . Though the prior report for January did show higher costs for basics, only a limited increase is expected for February's core rate (less food & energy) which is seen up a modest 0.2 percent with the year-on-year expected to rise 1 tenth to 1.9 percent. The consensus for the headline CPI is also a monthly gain of 0.2 percent for a yearly rate that is also seen up 1 tenth, to 2.2 percent.


 

Wednesday


 

PPI-FD for February

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.1% to 0.5%


 

PPI-FD Less Food & Energy

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.2% to 0.3%


 

PPI-FD Less Food, Energy, & Trade Services

Consensus Forecast, Month-to-Month Change: 0.3%

Consensus Range: 0.2% to 0.3%


 

Boosted by increases in service prices, producer prices resumed their march higher in January though forecasters are calling for moderating increases in February. The headline consensus is plus 0.2 percent. Less food and energy is seen up 0.2 percent with less food, energy and trade services expected to rise 0.3 percent.


 

Retail Sales for February

Consensus Forecast: 0.4%

Consensus Range: 0.1% to 0.6%


 

Retail Sales Ex-Autos

Consensus Forecast: 0.4%

Consensus Range: 0.2% to 0.6%


 

Retail Sales Ex-Autos Ex-Gas

Consensus Forecast: 0.4%

Consensus Range: 0.0% to 0.5%


 

Retail Sales Control Group (Ex-Food Services, Ex-Autos, Ex-Gas, Ex-Building Materials)

Consensus Forecast: 0.5%

Consensus Range: 0.1% to 0.7%


 

After weak results in December and January, retail sales are expected to show some snap back in February with Econoday's consensus at a solid 0.4 percent. When excluding autos, where unit sales were flat in February, forecasters also see a 0.4 gain percent as they do when excluding both autos and also gasoline. When excluding autos, gas, food services and building materials, control group sales are expected to come in at a 0.5 percent gain.


 

Business Inventories for January

Consensus Forecast,  Month-to-Month Change: 0.5%

Consensus Range: 0.3% to 0.6%


 

A sizable build of 0.5 percent is expected for January business inventories, an increase that would give an early boost to the inventory component of first-quarter GDP.


 

Thursday


 

Initial Jobless Claims for March 10 week

Consensus Forecast: 230,000

Consensus Range: 225,000 to 235,000


 

Initial claims are expected to come in at 230,000 in the March 10 week vs 231,000 in the prior week. Claims have been low and consistent with minimal layoffs and strong demand for labor.


 

Import Prices for February

Consensus Forecast, Month-to-Month Change: 0.3%

Consensus Range: -0.1% to 0.4%


 

Export Prices

Consensus Forecast, Month-to-Month Change: 0.3%

Consensus Range: 0.1% to 0.5%


 

Import prices, boosted by increases in vehicles and food, showed pressure in the January report even when excluding petroleum. Moderation is the call for February with import prices expected to rise a moderate 0.3 percent with export prices also seen at an increase of 0.3 percent.


 

Philadelphia Fed Manufacturing Index for March

Consensus Forecast: 23.3

Consensus Range: 20.0 to 26.8


 

At a March consensus of 23.3, robust strength is once again the expectation for the Philly Fed manufacturing index. Rising backlogs and expectations of rising selling prices are the latest trends in a sample that would appear to be at risk of hitting capacity constraints.


 

Empire State Index for March

Consensus Forecast: 14.6

Consensus Range: 10.2 to 16.0


 

A bit cooler than the Philly Fed, expectations are nevertheless strong for February's Empire State index where the consensus is 14.6. Increased hiring, slowing deliveries, and traction for selling prices are some of the signs of capacity stress in this report.


 

Housing Market Index for March

Consensus Forecast: 72

Consensus Range: 70 to 73 


 

Home-builder confidence has been extremely strong with improvement in customer traffic an ongoing highlight. Assessments of current and future sales have been robust and have offered useful indications of gains for new home sales and permits. Econoday's March consensus calls for steady strength, at 72 for the housing market index which would be unchanged from February.


 

Friday


 

Housing Starts for February

Consensus Forecast, Annualized Rate: 1.284 million

Consensus Range: 1.256 to 1.322 million


 

Building Permits

Consensus Forecast: 1.324 million

Consensus Range: 1.300 to 1.392 million


 

Less strength is the expectation for February housing starts where the consensus is a 1.284 million annualized rate vs January's 1.326 million, as well as for housing permits, at a consensus 1.324 million rate vs 1.377 million. Starts and permits both surged in January led by the key single-family component. Note that the consensus ranges for both are wide.


 

Industrial Production for February

Consensus Forecast, Month-to-Month Change: 0.3%

Consensus Range: 0.0% to 0.7%          


 

Manufacturing Production

Consensus Forecast,  Month-to-Month Change: 0.4%

Consensus Range: 0.2% to 1.0%


 

Capacity Utilization Rate

Consensus Forecast: 77.7%

Consensus Range: 77.4% to 77.9%


 

Industrial production has been held back by weakness in the report's manufacturing component though a bounce back, based on a factory-hour rise in the employment report, is the call for February, at a 0.3 percent increase overall and a 0.4 percent gain for manufacturing. Overall capacity utilization has been on the climb and another increase is expected, to 77.7 percent vs January's 77.5 percent.


 

Consumer Sentiment Index, Preliminary March

Consensus Forecast: 98.5

Consensus Range: 97.0 to 101.5


 

The consumer sentiment index is expected to open March at a preliminary 98.5 and down from February's 99.7. This report, which had been flat compared to other confidence reading, jumped sharply in February despite volatility in the stock market.


 

JOLTS: Job Openings for January

Consensus Forecast: 5.800 million

Consensus Range: 5.800 to 5.890 million


 

Job openings are expected to hold steady in January at 5.800 million vs December's lower-than-expected 5.811 million which marked the third decline in five months and pulled down the year-on-year gain to what is a still healthy 4.9 percent. In an economy at or close to full employment and possibly nearing the risk of wage inflation, a bit of cooling in openings might be a welcome sign of cooling.