The biggest jobs report takeaway is the growth in non-farm payrolls
There are a lot of little nuggets to glean from the payroll report released in the US today. On the whole, the report didn’t move the needle decisively in either direction. Nevertheless, there is one big takeaway. And that’s that job growth has now begun a slight re-acceleration. If this trend holds, the unemployment rate will drop into the mid 3% range and the Fed will move to a fourth rate hike.
Job growth is a leading indicator, not a lagging one
I’m not going to go into detail about all of the other factors in this report. You will have read about them somewhere else. I want to focus you on what matters – and that’s directionality. From an investing and business standpoint, what you want to know is whether the numbers confirm or rebut the trend and whether they show acceleration or deceleration. So that’s what I am going to focus on.
Now, this is important, because we are very late in the cycle — within a whisker of the longest US business cycles on record. And as the unemployment rate pushes lower, people are looking for evidence that this is now the end of the cycle. That evidence was lacking in this report. In particular, take a look at the chart below.
Source: St. Louis Fed
You’re looking at the rolling year-on-year change in non-farm payrolls. And what matters is the slope of the curve. If it is positive, the economy is adding jobs at a faster pace and that is causing growth to accelerate. If the slope is negative, the economy decelerates. And when the slope is steeply negative, recession is right around the corner.
The first thing you will notice is that this is a leading indicator, not a lagging one. That means you can look at jobs data and predict where the economy is headed. We’ve been told jobs are a lagging indicator. That’s simply not true. Every recession since this data series began was preceded by a fall in the year-on-year growth in jobs. Only in July 1953 was this indicator coincident as the demilitarization following the Korean War hit hard and fast.
The Mid-1990s jobs growth pause example
The problem is that jobs growth can decelerate and then re-accelerate. So a mid-cycle slowdown does not have to end in recession just because year-over-year growth in non-farm payrolls begins to decline. The mid-1990s is a perfect example.
Source: St. Louis Fed
The year on year change in non-farm payrolls peaked mid cycle as the first US ‘jobless recovery’ gathered pace slowly. The Fed saw the job growth and resumed interest rate hikes in January 1994. This interest rate hike campaign finally started to bite and job growth rolled over 13 months later in February 1995. The Fed stood pat until June and then began to cut as it realized a recession loomed.
That did the trick. And the economy continued to power forward without a recession.
But notice, job growth never reaccelerated to the 1995 peak. It re-accelerated, yes. But never to more than 3.5 million jobs added in any 12-month period. The 1995 peak was 3.9 million.
So what about job growth now?
In this cycle rolling 12-month job growth has been range bound. And while it was modestly decelerating up until this year, it has ticked up every month in 2018 from a January low.
Source: St. Louis Fed
We are going to have to see this trend reverse and deteriorate significantly for there to be any deceleration in growth into an end of cycle. In fact, forget about recession. The numbers speak to growth re-acceleration rather than deceleration. My expectation is for continued GDP growth trending toward the 3% range. Q1 was probably an aberration due in part to uncorrected residual data seasonality.
The Fed stands ready for four rate hikes
This analysis show you an economy firing on all cylinders. And the unemployment rate has dipped into the 3% range. I have long predicted mid-3% range by year end given the present trend. Fed forecasts do not reflect this likelihood though. The Fed last projected a year-end rate of 3.8%. And we are already at 3.9%. And it’s still April.
That makes four rate hikes for 2018 likely. It also could mean an accelerated timetable for 2019. The risk, of course, is that we are late cycle. 2018 is not akin to 1995 when the Fed backed off its rate hike train and reversed course. It is more akin to 1999 when the Fed dodged the LTCM bullet and begun to hike again.
The mix of continued job growth, tightening monetary policy, and late cycle dynamics are a dangerous combination. And that danger will be felt most acutely in 2019.