In today’s age of “data-dependent” central banks, investors have become hyper-focused on economic data releases, trying to discern any potential changes in monetary policy. One particular report that seems to attract outsized investor – and media – attention is the monthly release of the U.S. employment situation, which captures the change in total non-farm payrolls (NFP) and average hourly earnings.
Notably, the two most recent NFP numbers for March and April lagged consensus at 135,000 and 164,000 respectively. Similarly, the increase in average hourly earnings came in slightly below expectations at 2.6% annualized in the latest report. At the surface, these data points may indicate some remaining slack in the employment picture. The lack of wage pressure in particular is causing some investor concern on potential softness in economic activity, which could slow the Federal Reserve’s path to rate normalization.
Our take however is that there is a larger, more structural factor at play, driving the “slowdown” in payroll growth: demographics.
Taking a step back, the average number of new jobs added each month has hovered around an impressive 200,000, as the U.S. economy continues its long recovery from the credit crisis. These robust levels of job growth have driven the unemployment rate to an 18-year low of 3.9%.
As economic slack gets used up, we argue that NFP numbers will (and should) trend lower, guided by demographic trends. Projections by the Bureau of Labor Statistics (BLS) indicate U.S. population growth – and more importantly, labour force growth – will slow in the coming years, due to factors like declining fertility rates and aging baby boomers.
As for what the long-term figure is for monthly payrolls, it depends on a range of variables, though past statements from the Fed have indicated a sustainable level may be closer to 100,000 per month. Whatever that number may be, it’s clear investors will have to adjust expectations and recognize the larger economic forces at play.
Besides adjusting expectations, investors should contemplate the policy implications as well. An economy’s operating speed, or potential growth, is a function of the relative inputs of labour and investments. Traditionally, an economy operating above its speed limit and constrained by labour supply will experience wage inflation and potentially invite a pickup in the pace of monetary tightening leading to market turbulence manifested in higher interest rates and a pickup in volatility. Alternatively, corporations can compensate for the labour squeeze by increasing spending on investments to boost productivity and maintain operating margins. In the current expansion, wages are showing signs of accelerating while productivity gains have been muted.