Tighter labour market but still waiting for inflation

Job report preview

• We estimate job growth of 205,000 in August, which is in line with consensus. Overall, labour market indicators released lately have been solid, with jobless claims data trending sideways at a low level and the Conference Board’s labour market differential at its most favourable level since January 2008.

• Average hourly earnings is still not showing any substantial pickup in wage inflation contrary to what could be have been expected given the tighter labour market. The employment cost index (ECI) for Q2 was also soft and, in general, wage inflation has fluctuated around 2% y/y over the past two years. We continue to expect wage inflation to pick up as we move towards year-end and look for slightly higher earnings growth in August.

• We estimate that the unemployment rate declined to 5.2% from 5.3% and is thereby approaching the Fed’s NAIRU of 5%. The unemployment measure is often highly correlated with the Conference Board’s labour market index ‘jobs plentiful less jobs hard to get’, which surprised positively in August by increasing to 0.0 from -7.5. This means there is some risk that the unemployment rate will be even lower.

General condition of the US labour market

• US data continue to show progress, best summarised by the upward revision of Q2 GDP growth to 3.7% q/q AR from 2.3%. We expect GDP growth to cool somewhat in Q3, as companies reduce the pace of inventory accumulation but we continue to see GDP growth above trend this year and next. This implies that downward pressure on the unemployment rate will continue.

• In particular, we expect unemployment to undershoot the FOMC’s projection even though our GDP growth projections are in line with the FOMC’s. The reasons for this are twofold. First, we do not see a major up shift in labour productivity over the coming year; hence, the number of employees needed to produce each dollar of output will remain high. Second, we do not expect a significant cyclical rebound in the labour participation rate but at best a short period of stagnation before demographic factors push the participation rate even lower. This is a key reason we think the Fed will initiate its tightening cycle in December this year and proceed at a faster pace than the two hikes currently factored in by the market.

• One headwind to our Fed call is the low level of inflation. Following the Jackson Hole Symposium this weekend (see Fed Update: Wrap up on Jackson Hole, 30 August) we are more confident that the Fed will look through the current low level of inflation and focus on the slack in the economy to judge where future inflation is heading. This said, we believe the Fed will wait until December to hike rates and use the coming months to build confidence that inflation is heading higher.