This Is Not the Dawning of the Age of Aquarius
Ongoing expenditures growth implies financial markets can afford to wait patiently for a lower federal funds rate. However, if an end to progress at consumer price disinflation were to bring a Fed rate hike into view, markets would tank.
Thus, the most important statement by Jerome Powell in his recent congressional testimony may have been, “We believe that our policy rate (fed funds) is likely at its peak for this tightening cycle”. Nevertheless, there is no guarantee that the FOMC may not abandon this belief, especially if material economic growth amid an already tight labor market triggers an inflationary wage-price spiral.
On the labor compensation front, the Fed’s semiannual Monetary Policy Report noted a welcome slide by the annual rate of growth for the employment cost index (ECI) from June 2022’s 5.1% peak to the 4.2% of December 2023. Nevertheless, labor compensation grows much too fast to feel confident about the nearness of a 2% recurring annual rate of core PCE price index inflation.
For 2015-2019, the average annual rates of growth were 2.5% for the ECI and 1.6% for the core PCE price index. Granted that a drop by the ECI’s underlying rate of growth to 2.5% may be unduly severe but getting to a 2% recurring rate of core PCE price index inflation may require an average annual rate of ECI growth that is not much greater than 3%.
The now rapid growth by the compensation of government employees may help to prevent a disinflationary deceleration by the ECI. For example, December 2023’s 4.2% year-on-year increase for the ECI of all civilian workers was unevenly divided between gains of 4.1% for private-sector workers and 4.6% for state and local government employees. Election year politics may prevent government employee compensation from slowing in 2024.
Rapid growth for wages and salaries keeps interest rates high …
In terms of wage and salary incomes received during the three-months-ended January 2023, the 6.5% increase for all employees consisted of advances of 6.2% for private-sector workers and 7.9% for all government employees.
Also, the three-months-ended January 2024 saw year-over-year increases of 4.5% for all wage and salary income received per job, 4.4% for wage and salary income received per private-sector job, and 4.8% for wage and salary income per government job.
Remember, the growth of employee compensation offers insight on more than the cost pressures facing employers. Employee compensation also sheds light on (i) the likely growth of household expenditures, and (ii) the ability of consumers to absorb higher prices without reducing unit purchases. By making higher prices more affordable, the faster growth of wages and salaries enhances the pricing power of businesses and the taxing power of governments.
Today’s combination of material expenditures growth amid a tight labor market warns of the above-average risk of an inflationary wage-price spiral. The only way of ending a wage-price spiral is through a big enough rise in joblessness that puts considerable downward pressure on employee compensation. And that is precisely what occurred during 2008-2009’s Great Recession.
Labor productivity surge may be short-lived …
Since the end of 2023’s first quarter, US labor productivity has grown at a super-charged annualized rate of 3.7%. For a seasoned economic recovery, labor productivity’s latest three-quarter-long annualized rate of growth was the fastest since the 3.8% of the three- quarters-ended March 2004. Nevertheless, productivity subsequently slowed to a more pedestrian 1.8% average annualized pace for the three years ended March 2007.
It is premature to declare that the US has entered a new age of rapid productivity growth.
The rapid labor productivity growth of 2023’s final three quarters was the offshoot of average annualized changes of +3.7% for output and 0.0% for hours worked at nonfarm businesses. The latter differed considerably from the accompanying +1.6% annualized increase by nonfarm private-sector payrolls during 2023’s final three quarters.
The simultaneous stall by hours of work and expansion of payrolls is unsustainable.
Barring a notable expansion by hours of work, businesses may respond to shortened hours by paring staff. To the degree smaller additions to payrolls curb household expenditures, lower than expected spending will slow the growth of output to an annualized pace well under the 3.7% of 2023’s final three quarters. Much slower output growth could decelerate labor productivity considerably.
The 3.8% annualized productivity growth of the three-quarters-ended March 2004 was the product of annualized growth rates of 5.3% for output and 1.4% for nonfarm-business hours of work.
Unlike today’s imbalance between the private-sector’s growth of jobs and unchanged hours of work, the 0.9% annualized rise by private sector payrolls of the three-quarters-ended March 2004 was slower than the 1.4% annualized rise by hours. Back then, the relatively faster growth for hours of work suggests March 2004’s prospects for hiring activity were more favorable than those of today.
Indeed, private nonfarm payrolls would grow at an average annualized rate of 1.8% during the three-years-ended March 2007. Such a pace seems impossible for the three years ended 2027 given the limited upside for noninflationary jobs growth implicit to January 2024’s historically low 3.7% unemployment rate and accompanying 4.5% annual rate of wage inflation.
Mid-1990s’ soft landing owed much to higher jobless rate, slower wage growth, and fiscal discipline …
Paraphrasing an op-ed piece in March 4’s Wall Street Journal (WSJ), when the US economy was growing rapidly during the mid-1990s, Fed chair Alan Greenspan dissuaded the FOMC from hiking fed funds because he correctly recognized a labor productivity surge that would allow the US economy to grow materially without incurring rapid price inflation.
The WSJ article mentioned that the unemployment rate was low during the mid-1990s. In other words, the article appears to be assuming that despite the tight labor market of the 1990s, labor productivity was rapid enough to make room for noninflationary economic growth.
I will now go ahead and refute the notion of a tight labor market during the mid-1990s, which was the only post-WWII episode where a substantial hiking of the federal funds rate from 3% to 6% was not immediately followed by a recession.
When fed funds peaked at the 6.00% of 1995’s second half, not only did the unemployment rate average a relatively slack 5.6%, but the average hourly wage of production workers and nonsupervisory personnel grew by 2.6% annually, on average. The latter was far slower than January 2024’s year-over-year growth rates of 4.5% for the average hourly wage of all private-sector workers and the 4.8% jump by the average hourly wage for production and nonsupervisory personnel.
Note that the average hourly wage for all private sector employees was not publicly available until March 2006. Prior to March 2006, only the average hourly wage of production and nonsupervisory personnel was published.
By most measures, today’s labor market is much tighter than that of the mid-1990s. In turn, one should be less confident of the nearness of Fed rate cuts and more wary about a recession that might be the only way of achieving a 2% recurring rate of core consumer price inflation. The outcome of November’s presidential and congressional elections may help to remedy the inflationary bent of government spending, subsidies, tax policies, and regulation.
Today’s fiscal jolt is unprecedented given a historically low unemployment rate amid a peacetime economy. Government intervention helps explain why 2023’s real GDP growth surpassed consensus forecasts and why inflation risks remain elevated.
Calendar year 2023’s 4.0% annual advance by real government spending was joined by a federal budget deficit that approximated 6.2% of GDP for fiscal year 2023. By contrast, real government spending barely rose by 0.3% annually, on average, during 1994-1995. Moreover, the federal budget deficit averaged a comparatively small 2.5% of GDP during the mid-1990s.
Mid-February’s consensus forecast puts 2024’s federal budget deficit at a still historically high 6.0% of GDP. In addition to a persistently wide federal budget deficit, the continued expansion of government regulatory activity also will help to preserve above-average inflation risk.
Despite rapid jobs growth of December and January, hours of work shrank …
Private sector hours of work equal the number of private-sector jobs times the length of the average workweek.
February’s average workweek ought to top January’s 34.1 hours. January’s average workweek of 34.1 hours was in the bottom decile of its available sample. Both the median and average for the average workweek equal 34.4 hours. The average is surrounded by a standard deviation of +/- 0.2 hours.
Despite the average monthly addition of 298,000 jobs to private-sector payrolls in December 2023 and January 2024, total private-sector hours of work fell by -0.2% per month, on average, for the same two months. In turn, January’s estimate of private-sector hours was up by merely 0.3% from a year earlier.
I believe 0.3% yearly growth by private-sector hours of work severely understates the health of the US economy. Thus, February’s private-sector hours probably rebounded to at least a 1.0% yearly increase. However, if private-sector hours’ yearly increase remains under 1% for February, the odds favoring a May or June Fed rate cut will rise.
Recent surge in discouraged workers has recessionary precedents …
The number of jobless individuals who want a job but are no longer actively seeking work after having searched for a job in the previous 12 months posted year-to-year increases of 24.4% in December 2023 and 22.5% in January 2024. By contrast, during the 12-months-ended October 2023, the number of recent labor force dropouts who wanted a job shrank by -6.3% annually, on average.
Previous annual advances of at least 20% by the number of recent labor force dropouts wanting a job first materialized in April 2020 (up 56.0%), August 2008 (up 20.1%), and August 2001 (up 24.3%). Each of the three cited months overlapped a recession.
Recent bottomings by both the official jobless rate and the U6 unemployment rate (which counts discouraged workers among the unemployed) may be the harbingers of a long- awaited slowdown by expenditures. If true, a meaningful slackening of the labor market will open the way for significantly lower benchmark interest rates.
Labor force participation rates change considerably across age cohorts …
All else the same, the relentless and unprecedented aging of the US population will skew the US’ labor force participation rate downward going forward.
The percent of the US’ working age population aged 65 years and older rose from February 2020’s pre-COVID 20.78% to January 2024’s record high 22.0%. At the same time, the labor force participation rate for the 65-years and older age cohort fell from February 2020’s record high 20.77% to January 2024’s 19.1%.
As the 65-years and older age cohort ages, the group’s labor participation rate ought to decline. You can be 85 years old and still be included in the working age population provided that you have not been institutionalized.
Also, the frequency of retirements among those still working beyond the age of 65 years probably increased for reasons that were either involuntary or voluntary. The powerful post-February 2020 equity rally (the market value of US common stock was recently up by a cumulative 67% -- or $20 trillion -- since February 2020) and accompanying home price appreciation (the Case Shiller home price index recorded a 44% advance since February 2020) facilitated an increase in permanent retirements. According to an analysis reportedly conducted by the St. Louis Fed, fourth-quarter 2023’s retirements exceeded the number of projected retirements by 2.7 million.
Despite an increased incentive to retire early, the labor force participation rate for the 55-year to 64-year age cohort increased from February 2020’s 65.2% to January 2024’s 66.1%. However, the latter masked a -2.2% drop in the number belonging to the 55- to 64-years age cohort from February 2020 to January 2024 that was joined by a -1.0% drop in the employment of those 55 to 64 years of age.
Foreign born gain on native born in terms of employment and population …
According to January 2024’s household survey, employment rose by 0.6% year-on-year, wherein the 4.0% yearly advance by the employment of foreign-born workers differed considerably from the -0.1% yearly dip by the employment of native-born Americans.
Also in January, the US population grew by 0.59% from a year earlier, wherein the 3.58% yearly jump by the foreign-born population far outpaced the accompanying -0.03% dip by the number of native-born Americans.
The percent of the US population that is foreign born has risen from April 2010’s latest low of 14.7% to January 2024’s 17.8%.
Rebound by auto sales from January’s plunge lessens need for Fed rate cut …
Real consumer spending has yet to slow by enough to strongly favor a lowering of the federal funds rate by the middle of 2024.
The latest good news on the US’ unit sales of cars and light trucks weighed against the urgency of a Fed rate cut. After sinking by -6.6% monthly in January, February’s seasonally-adjusted unit sales of light motor vehicles may have grown by nearly 6% from January’s pace.