Chief Economist Scott Brown discusses current economic conditions.
The Labor Market Outlook – Nonfarm payrolls rose by 559,000 in the initial estimate for May, below the median forecast (+650,000), but less of a disappointment than in April (when payrolls rose by 278,000). Leisure and hospitality accounted for more than half of the May payroll gain, but jobs in the sector are still down by 2.5 million (-15.0%) from February 2020. The report suggests that we have a long way to go for the kind of improvement in labor market conditions that would lead the Fed to begin raising short-term interest rates. Economic growth is expected to remain strong, but labor market frictions are likely to be a restraint and could add to inflation pressures in the near term.
Prior to seasonal adjustment, payrolls rose by 973,000 in May, up 3.25 million since February. That (unadjusted) pace is better than the four previous pre-pandemic springs, but it still leaves us with a large amount of labor market slack. Nonfarm payrolls are down 7.6 million (-5.0%) from February 2020 and we would have added two million jobs if not for the pandemic – so we’re about 9.6 million below the pre-pandemic trend. At the recent pace, it will take more than a year and a half for a full job market recovery.
The unemployment rate fell to 5.8% in May, due partly to a decrease in labor force participation (don’t read too much into that, there’s a fair amount of noise from month to month). Long-term unemployment remains elevated. That’s not good. The long-term unemployed will lose skills over time and typically have a harder time finding work even as the job market improves.
Extended federal unemployment benefits are set to end around Labor Day. However, half of the states have already moved to curtail them sooner. The view is that these benefits prevent low-wage workers for accepting jobs – and these benefits are a disincentive for some workers. However, we can see that a full recovery in the job market is going to take some time, labor market frictions will remain at a high level, and many of the unemployed will be unable to find work for months.
Employers can attract workers by raising wages, and in some cases, they have. One problem is that by raising starting wages, existing employees are likely to demand more, and in a hot job market, they may leave to pursue better alternatives. Firms are still relying on signing bonuses and other perks to attract new workers, much as they did in the strong pre-pandemic job market.
Importantly, we are not in a labor shortage. What we have is elevated labor market frictions, made worse by the sheer magnitudes involved (millions of unemployment workers, millions of available jobs). It’s not always easy to find workers. It takes time to interview and to negotiate. There are going to be informational issues. Firms may not know where to find workers. Workers may not be able to discover what jobs are available (this is a particular problem for low-wage workers, who may not have access to the internet).
For Fed policymakers, the key is whether labor market frictions will lead to a substantial, sustained increase in inflation. The labor market will clear over time, and one would expect higher wage growth to lead to a more productive allocation of labor (which may not be all that inflationary), but there is going to be more uncertainty in the near term.
Recent Economic Data
The Fed Beige Book reported that economic growth was “moderate,” although “somewhat faster” than the previous assessment. Firms reported difficulties in hiring, especially for low-wage workers, truck drivers, and skilled tradespeople, but wage increases were described as “moderate” overall. Amid ongoing supply chain bottlenecks, input price pressures increased further, which “some” businesses could pass along.
The ISM Manufacturing Index rose to 61.2 in May (vs. 60.7 in April), reflecting faster growth in new orders and production. The ISM Services Index rose to a record 64.0 in May (vs. 62.7 in April), with faster growth in business activity and new orders. Both reports indicated longer supplier delivery times, rising order backlogs, and increased input price pressures.
Nonfarm payrolls rose by 559,000 in the initial estimate for May (+973,000 before seasonal adjustment). Leisure and hospitality added 292,000 (1.26 million in the last four months), but retail fell by 5,800 and construction fell by 20,000. State and local education added 103,000 (down 83,000 before seasonal adjustment).
The unemployment rate fell to 5.8% in May (from 6.1% in April), partly reflecting lower labor force participation.
The ADP estimate of private-sector payrolls rose by 978,000 in May, down 7.38 million from February 2020.
Unit motor vehicle sales fell to a 17.0 million seasonally adjusted annual rate in May, down from an 18.8 million pace in April and 18.0 million in March – still high by pre-pandemic standards.
Gauging the Recovery
The New York Fed’s Weekly Economic Index was little changed, at +10.79% for the week ending May 29, vs.
+11.29% a week earlier (revised from +11.35%), signifying strength relative to the depressed level of a year ago. The WEI is scaled to year-over-year GDP growth (GDP was down 9.0% y/y in 2Q20).
Breakeven inflation rates (the spread between inflation-adjusted and fixed-rate Treasuries, not quite the same as inflation expectations, but close enough) continues to suggest a moderately higher near-term inflation outlook. The 5-10-year outlook has crept a bit above the Fed’s long-term goal of 2% (but not by a lot).
As more people become vaccinated, the number of COVID-19 cases continues to trend lower. Despite the downtrend in new cases, we are still losing more than 3,000 people per week (vs. 4,000 at the end of April).
Jobless claims fell by 20,000, to 385,000 (another pandemic low), in the week ending May 28. Claims are trending lower, but are still well above pre-pandemic levels (a little over 200,000).
The University of Michigan’s Consumer Sentiment Index fell to 82.8 in the mid-month assessment for May (the survey covered April 28 to May 12), vs. 88.3 in April and 84.9 in March. The increase reflected growing concerns about inflation. The expected inflation rate for the next year rose to 4.6% (from 3.4% in April), while the expected rate for the next five years rose to 3.1% (from 2.7%). Two-thirds of those surveyed expect the Fed to raise short-term interest rates within a year.
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