Fed Watch: Still in the Game

Tim Duy with a Fed Watch after today's jobs report:

Still in the Game, by Tim Duy: The title could refer to the Fed or myself, considering my long hiatus from Mark’s blog. In this case, however, it is the Fed I am referring to. The jobs report was mixed, but tilted enough to the “strong” side to keep the more hawkish FOMC members fidgeting nervously. Yes, the headline reading of 121,000 net new hires in May argues for a pause at the next meeting. But the rest of the report argues for another 25bp. And, given last month’s wave of hawkish rhetoric, caution suggests following the latter bet.

First, note that the Fed was perfectly happy to raise rates after the last employment report, which posted a 75k gain in employment (since revised up to a 92k gain) and a measly one cent gain in hourly earnings. Did I say “perfectly happy?” Note the John Berry would not agree with me on this point. He claims that:

Some officials, convinced that economic growth is slowing and that inflation will settle down again soon, would really rather not raise the target this week for the 17th time in a row.

Even those officials feel they have no choice because investors, shaken by recent inflation reports, fully expect them to do so.

True, I think that some officials, such as the nonvoting Kansas City Fed President Thomas Hoenig and the voting San Francisco President Janet Yellen (whose bank did not put in a request for a discount rate increase) did not want to hike rates again. But to blame the rate hike on investors “shaken by recent inflation reports” misses half the story – the policy half. Berry forgets that most of the Fed finally found a consistent voice in the weeks prior to the meeting. And that voiced screamed “inflation.” No, the markets did not lead the Fed. In my opinion, the Fed decided to lead. Berry’s contacts (whoever they might be) shouldn’t blame the markets. They should blame their colleagues. And Berry shouldn’t help them shift the blame.

Given that a weak May report did not deter the Fed, why would a better June report argue for a pause? Employment gains accelerated, hours worked expanded, and both the duration of unemployment and the percentage of long term employed dropped. And then there is that wages jump – a “whopping” eight cents! Yes, yes, eight cents aggregated over millions of workers and hours does add up to real money, so it is significant. Moreover, average wages stand 3.9% higher than year ago levels. This will suggest to some FOMC members that the tepid employment growth remains strong enough to generate inflationary pressures. Recall arch-hawk Chicago Fed President Michael Moskow’s speech last month:

With overall population growth continuing to slow and labor force participation not expected to rise, we probably need to adjust our benchmarks for what level of employment growth is consistent with economic growth near potential and a steady unemployment rate. It used to be that increases in payroll employment that averaged 150,000 per month were consistent with flat unemployment. Now that number may be closer to 100,000. These developments also imply that, in the absence of changes in productivity growth, our estimates of potential GDP growth should be revised down 2 or 3 tenths of a percentage point to a range of 3 to 3-1/4 percent.

I am sure that Moskow will note that 121k is higher than his 100k estimate for a steady unemployment rate. For like minded FOMC members, this report suggests the economy is uncomfortable close to potential, and not slowing enough to stave off inflationary pressures. Instead, rising wages implies that workers have the gall to demand higher wages to compensate for accelerating inflation.

Of course, there is another side to this story – that these wages gains will be offset by productivity growth, and thus are not inherently inflationary. And while wages are up 3.9%, CPI headline inflation will post a greater y-o-y increase in June (the May number was 4.2%). In other words, real wages are down. Should we expect the Fed to hike rates when real wages are falling, or whenever they threaten to edge up? Is the goal to hold real wages constant? See Angry Bear for more on this criticism of Fed policy.

The Fed, I suspect, will not cozy up to these arguments. On the first point, policymakers will note the possibility that, given the “tight” labor market – 4.6% unemployment – this is only the first round of wage gains that will start to push up unit labor costs. On the second point, they will note that the wage section of the employment report covers only 80% or so of the workforce – the 80% FOMC members do not encounter unless they work late enough for the janitorial staff to make the rounds. Just kidding, sort of. They will note that real disposable personal income is 1.4% higher than a year ago. Real incomes are rising, not falling! Naturally, the rise is attributable to gains at the top of the economic heap. But the distribution of gains is not within the purview of monetary policy. Fed officials will argue that topic is in the realm of the legislative and executive branches of government (the Fed didn’t give tax cuts to the wealthy). The Fed addresses policy to the nation as a whole, not to individual subgroups or sectors. And more importantly, households still appear willing to spend, albeit at a slower pace and at the expense of savings.

Bottom line: I want to believe that the Fed will pause as they assess the magnitude of economic slowing. But I have been led down that road before, and am not ready to make that trip again. Instead, I suspect they will read this report as a sign that while the economy is slowing, the pace of activity remains strong enough to heighten inflationary pressures. True, we will get another employment report before the next FOMC meeting, as well as multiple reports on inflation, not to mention Q2 GDP as well as the minutes from the last FOMC meeting. And Fed officials may suddenly back away en masse from last month’s inflation worries. But this employment report goes to the hawks.

Update: The Wall Street Journal's Greg Ip explains the difference between the payroll and household survey of unemployment using the latest employment numbers to illustrate the difference:

Jobs Surveys Send Divergent Signals, by Greg Ip, WSJ: While Friday's employment report showed a disappointing increase of just 121,000 in nonfarm payrolls in June, optimists noted that the separate survey of households showed employment had jumped 387,000.

But the picture would be different if the two surveys defined employment the same way. If they did, then the household survey would have shown a decline in jobs of 92,000, the Bureau of Labor Statistics estimates.

The two surveys often send different signals, but the differences have been especially large lately. Since December, payroll jobs are up 854,000 while household employment is up 1,584,000. Since both surveys estimate total employment from a sample, neither is a perfect tally but economists generally prefer the payroll survey because its sample is far larger -- about 400,000 establishments, compared to the household survey's 60,000 households.

In theory, the two could be completely accurate yet come up with widely different job counts, because they define employment differently. In June, these definitional differences accounted for more than the entire difference in the two results.

Of the many definitional differences, the largest, in terms of magnitude, are that the household survey counts the self-employed while the payroll survey does not; and that the payroll survey counts someone with two jobs twice, whereas the household survey counts that person once.

Each month, the BLS comes up with a household estimate of employment as using the payroll survey's definition of employment. In June, that total showed a decline in jobs of 92,000 from May. (You can see the estimates and a technical note on their web site here: http://www.bls.gov/web/ces_cps_trends.pdf1)

Is this positive or negative news for the job market? The answer depends on the reason for the divergence. If it's because the ranks of the self-employed are growing, the job market is stronger than the payroll survey suggests. If it's because the number of people with multiple jobs is shrinking, the market is weaker than the household survey shows -- all else equal.

In June, the message appears to be negative. The number of the self-employed rose 20,000. But the number of multiple job-holders fell 320,000, which means at least that many fewer paychecks from this group. (It may not mean less income: The worker may have gone from two part time jobs to one full time job.) But these two categories swing widely from month to month. In the last six months, the number of the self-employed has risen 346,000 while the number of multiple-job holders has fallen just 75,000.

Even using the payroll definition, the household data are still highly volatile; it showed a huge gain of 606,000 jobs in May from April, far more than the payroll survey's increase of 92,000.

Yet since last August, the two have told almost the same story: Jobs are up by 1.4 million according to the payroll survey, and 1.3 million using the household survey but the payroll definition. The household survey using the broader household definition is up by 1.9 million, which means about 600,000 extra jobs that can't be explained by definitional differences. It may be a sign, albeit an inconclusive one, that job creation is stronger than the payroll survey suggests.