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The unemployment rate has reached the Fed’s target, but some slack remains

After a very strong fourth quarter, employment growth in the US slowed significantly at the start of the new year, due to fewer jobs created in the services sector. The unemployment rate, on the contrary, dropped unexpectedly from 5.0% to 4.9% following two consecutive months of stabilization and is now in line with the Fed’s full employment target. While we expect the unemployment rate to extend its downtrend, the pace has slowed recently as more people are returning to the labour market. As a result, the participation rate picked up in December and January, showing signs of bottoming out. With more Americans returning to the labour force, also the broader U6 unemployment rate failed to drop further and remains significantly above our target, which suggests that there is still slack in the labour market. Also the long‐term unemployed share edged higher as it’s most challenging to find a job for those who are the longest out of work. Despite mixed payroll data, average hourly earnings surprised again on the upside. The annual rate of growth slowed but less than forecast as AHE increased by 0.5% compared with the month before. Wage growth remains well below the Fed’s target (3.5% Y/Y), but is on a sustained upward trend. With the current low levels of inflation, real wage growth is however not too bad.

The JOLTS report for December confirmed the strong momentum in the US labour market at the end of last year. The job openings rate jumped again to its record high in December, but the hires rate continued to lag, hovering just below our target. Further improvements were registered in the quits rate, which has now also met our target and the layoffs/discharges rate fell again to its record low.

A look at the table below confirms the US labour market recovery is strengthening further. Five of our ten pointers improved, two stabilized and three weakened. Even more encouraging, five indicators have now met our self‐defined target, compared with three in the previous months. Payroll growth fell back below our target, but the 3‐month moving average, which is our benchmark, remains well above. The hires rate is very close to our target, but in the remaining four (U6 unemployment rate, long‐term unemployed share, AHE and participation rate) there is still some way to go. Three of them are definitely moving in the right direction and the participation rate seems to have ended its downtrend too, although a return to our target is unlikely due to demographics. The unemployment rate has reached the Fed’s full employment target, but details point to still substantial slack. At the current pace of job growth however, slack is rapidly shrinking.

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