Full Employment Is Still a Long Way Off

(Bloomberg View) -- Even before the U.S. jobs report released Sept. 1 suggested that wage pressures remained muted, financial markets had been confused about the intentions of the Federal Reserve. In response to investor concerns, I would suggest that the economy is nowhere near full employment.

An unemployment rate ranging between 4.3 percent and 4.4 percent over the past three months suggested to many that the economy was at, or close to, full employment. That, combined with the surge of the Fed’s balance sheet from about $800 billion in late 2008 to the current $4.5 trillion, was expected by an overwhelming number of investors, and by the central bank itself, to push wages and prices to much higher levels.

This has not happened. The Fed’s preferred inflation indicator, the core personal consumption deflator, which excludes volatile food and energy components, rose by a mere 0.1 percent in July compared with June. Over the past year, prices rose 1.4 percent by this measure, well below the Fed’s target of 2 percent. Average hourly earnings of American workers increased by just 0.1 percent in August, and by 2.5 percent over the past year. The perceived tightness in the labor market from the low unemployment rate had been expected to push wages up faster than 3 percent. 

Market watchers have referred to the benign wage and inflation numbers in the face of the low unemployment rate and easy monetary policy as posing a conundrum for the Fed. Could inflation suddenly surge, putting the bank behind the curve? Should monetary authorities get on top of the situation by tightening aggressively, despite the slow rise in wages and prices? What the central bank does, and at what pace, is of critical importance to investors. If the Fed is behind the curve, for example, the need to raise rates could become urgent, and a correction in equity prices would be swift and substantial.

Yet three employment-related data points support the premise that the economy is nowhere near full employment, and signal that there is still a lot of slack in the labor market.

First, the average workweek declined to 34.4 hours in August from 34.5 hours in July (see chart below).  It has fallen from a peak of 34.6 hours in January 2016 -- a level never reached since.  And since hourly wages increased by only 0.1 percent in August compared with the preceding month, weekly earnings actually fell.  The average workweek and weekly earnings would have been expected to rise if Fed policy was having its desired impact.

Second, the August labor force participation rate of 81.6 percent for 25- to 54-year-olds, the prime working age group, was lower than the month before, and also well below 83.1 percent in December 2007 when the Great Recession began. A growing economy is typically accompanied by a rise in the participation rate as job seekers detect improved prospects.

Third, the U-6 measure of unemployment rate, also calculated by the Bureau of Labor Statistics, remained unchanged at 8.6 percent for the third consecutive month after rising from 8.4 percent in May. The U-6 calculation considers as unemployed those working part-time because they cannot find full-time jobs, or those who have left the workforce involuntarily. Contrary to what one would expect from a healthy economic recovery, the U-6 rate is at a level higher than where it was in the months before the start of the last recession.

The economy is not at full employment because a prolonged period of balance sheet expansion by the Fed, accompanied by near-zero interest rates, has resulted in subpar real GDP growth and an economy not strong enough to offer full-time jobs to all workers who seek them. The reality is that Fed Chair Janet Yellen, and some of her colleagues, believe that the economy has reached full employment.

Investors face a fork in the road regarding how the Fed may act next, and the implications the policies would have for the equities market. If the Fed initiates a paring of its balance sheet soon, and implements several rate hikes during coming months, it would likely push the economy into recession, and equities into a major correction.

Alternately, if the doves on the Federal Open Markets Committee prevail and further tightening is delayed, equities could get another leg up.

Which of the two measures the central bank actually follows would have more impact for investors than expecting infrastructure spending or tax reforms to push growth beyond the targeted 3 percent level.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Komal Sri-Kumar is the president and founder of Sri-Kumar Global Strategies, and the former chief global strategist of Trust Company of the West.

For more columns from Bloomberg View, visit http://www.bloomberg.com/view.

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