Is Demand Weak Or Is The Labor Market Full?

Labor Market Growth Reviewed

In this article, let's look at the December labor report. Job creation was solid, but missed estimates slightly. Also,  wage growth fell sharply especially for production and non-supervisory workers. And, the underemployment (U6) rate hit a record low. The current difference between the underemployment rate and the unemployment rate is 3.2%. Record low is 2.9% which was hit in the early 2000s. U6 rate includes those marginally attached to the labor force and the unemployed. Therefore, there might be still room for the U6 rate to drop further.

There are 2 ways to look at the labor market. You can say current low job growth is caused by cyclical weakness. Or you can say this is a result of the labor market getting fuller. Both arguments have truth to them. As you can see in the chart below, yearly job growth improved from 2.2% to 2.7% in 2018 and then fell to 2.1% in 2019. In 2018, service sector job creation was helped by the tax cut and there was a cyclical improvement in manufacturing.

In 2019, the tax cut boost went away and there was a downturn in manufacturing. Manufacturing sector clearly shows cyclical changes. But services sector has been showing slower growth (outside of 2018) because the labor market is fuller. There are fewer people who can work and pay has increased. 

Excluding the burst in 2018, job growth has fallen 3 straight years. It fell 0.4% in 2016 and then 0.1% in both 2017 and 2019. The economy was in solid shape in 2017. It didn’t have cyclical headwinds slowing growth.

A counterpoint to the concept that job growth is low because the labor market is full is the decline in wage growth. You don’t see a decline in wage growth if there’s a full labor market. On the other hand, the decline in production and non-supervisory wage growth was only in the last 2 months of 2019. Their wage growth went from 2.95% to 3.4% in 2019. We can say there was cyclical weakness in the last 2 months of 2019 (those reports are still subject to revisions).

Labor Force Participation Rate

Overall labor force participation rate stayed at 63.2%, meeting estimates. In November, it fell from a multi-year high. The aging population is a secular trend lowering the rate in the long run. Tightness of the labor market and the strength of the economy has held up the rate in the past 5 years. It will never get to the peak in the late 1990s/early 2000s. Even though women are much closer to that high (down just 2.6% from record peak). 

A difference between the male and female participation rate has fallen from 16% in 1995 to 11.7% in 2019. We expect the decline in this gap to continue, although, at a lower rate because it’s mostly gone. The next recession will cause the overall labor force participation rate to fall to a new multi-decade low. Mostly because of the aging population; females can’t counter this trend.

As you can tell by the previous paragraph, gender and age play a major role in the labor force participation rate. That’s why it's good look at the prime age labor force participation rate and the demographically adjusted participation rate. Prime age rate rose 0.1% to a new cycle high even though the overall rate was stagnant. 

In December, the rate was 82.9% which is the highest level since June 2009 which was the last month of the recession. Labor force participation rate and the prime age rate both fell after the recession ended. Decline during the recession was modest. Record high prime age rate is 1.7% higher than where it currently is. It’s just 0.5% off last cycle’s high.

As you can see from the chart above, the demographically adjusted labor force participation rate is just 0.2% below the average from 1999 to 2000. The end of the 1990s cycle was the best stretch for most labor statistics. Demographically adjusted employment to population ratio is above its 1999-2000 high, but not at a record high yet. It can get there with a few more months of labor market expansion.

New Cycle Low In Growth

Since ECRI likes to support its narrative that the economy is still in a slowdown even though its leading index has recently shown improvement, it’s no surprise they shared the chart below. Their call hasn’t been all wrong as there have been some weak spots in 2H 2019, but that hasn’t impacted stocks at all as investors have looked towards a potential recovery this year. As you can see, aggregate hours worked growth is at a new cycle low. That’s because there has been weakness in the length of the work week and job creation growth.

As I mentioned earlier, service sector job creation growth has fallen because the labor market is full. The manufacturing sector has seen weakness in job creation and the length of the work week because of the cycle. The manufacturing sector has a better chance of rebounding. Even if aggregate weekly hours worked growth doesn’t rebound sharply, I don’t think the cycle is over. We’d need to see negative growth for me to worry about a recession.

Low Wage Industries Outperform

It’s surprising to see low wage industries still had much higher wage growth than middle and high wage industries given the relative underperformance of production and non-supervisory jobs. Specifically, production and non-supervisory wage growth fell 9 basis points more than overall wage growth in December and represents about 80% of the labor market. This weighting explains how it’s possible for it and low wage industries to differ. 

Many expect strong wage growth from low wage industries in January as well since many minimum wage hikes will kick in. Production and non-supervisory real wage growth should be hit hard in December because of the yearly increase in oil prices. CPI report will tell us the details on Tuesday. Estimates are for headline CPI to increase from 2.1% to 2.3%.

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