“Will monthly payroll gains move up toward the solid pace they maintained earlier this year and in 2015?” In her remarks earlier this week in Philadelphia, that’s one of the questions Federal Reserve (Fed) Chair Janet Yellen said she and her colleagues will be wresting with, following the markedly reduced pace of U.S. hiring in April and May.
My answer to her question: It’s unlikely payroll gains will return to their prior strong pace. I expect the weaker jobs numbers to persist as the year progresses. Here’s why:
The rolling over of corporate profits
Payrolls tend to track corporate profits quite closely, with reduced earnings generally translating into lower payrolls with roughly a six-month lag. The recent rolling over of corporate profits, represented by the year-over-year four-quarter moving average turning negative, implies lower payrolls ahead.
Large-scale employment gains are difficult to sustain
The job market’s strength in recent years has driven down unemployment and resulted in labor market tightness. This tightness, in turn, has made it hard for payroll gains to continue their long stretch of historic strength.
A profound transition in the economy is underway
Perhaps most importantly, there is a significant industry mix shift taking place in the economy. For decades, the U.S. economy has been undergoing an economic transition, from a goods-producing engine to a service sector and technology powerhouse, and many of these new jobs have been created over the past three or four years.
Around 1980, U.S. personal consumption expenditures (PCE) were divided roughly evenly between income spent on physical goods and that spent on services. Since that time, however, growth in services spending has ballooned rapidly, while goods purchasing has grown more modestly. Indeed, today goods PCE comprises less than a third of total consumer spending, and services purchases have grown to more than twice the size of the goods component. Also since 1980, employment gains have closely followed this changing spending pattern, with the service sector creating many more jobs than goods-producing sectors. This labor market trend is very much in evidence in recent data too, with the service/information industries adding jobs much more rapidly than goods-producing sectors. Interestingly, service-sector employment has also shown itself to be more volatile than its goods counterpart, with the latter hovering near historically low levels.
So what does this mean for the Fed going forward? Despite the weakness in manufacturing payrolls (a loss of 36,000 jobs in goods-producing sectors in May) that accompanies this secular shift, labor market tightness has allowed for some moderate wage gains and further declines in the unemployment rate, beyond the influence of the declining participation rate. I believe both these factors will probably allow the Fed to hike interest rates as early as this summer or fall, a move to merely accommodative conditions that is long overdue.