Making sense of US employment data and the interest rate decision.

We have relative strength in certain sectors supported by a steady increase in employment and growth in consumer credit. The backdrop is weak domestic productivity and income growth, an unsettling composition of employment growth and global economic weakness, in particular a possible global trade shock centred in China. The US is still growing slowly and while there are signs the labour market is tightening there remains considerable structural slack and remaining structural imbalances of concern.

A rise in interest rates may well be needed in the light of growth in consumer credit, but I have concerns over the fact that wage growth has yet to ignite, that capital investment expenditure remains weak and that the Federal Reserve’s own views of economic growth potential may well be above that which the economy itself is able to produce. Has the US economy returned to the normalcy envisioned by policy makers and with it its interest rate setting policy? I think not, but I also feel that the divergence between income growth and consumer credit growth is a considerable problem and one that may come back to bite the US if China weakens further.

Has demand moved to a level that would generate capital expenditure that many feel is necessary to push growth back to higher levels and would a rising interest rate scenario cut this particular and necessary part of the cycle short? This critical intersect may be a key consideration in any interest rate decision.

If we look at the monthly rate of increase in private sector employment we do not have a boom but it would appear that the data traverses an historical sweet spot (blue line).  Skip to a rolling 15 year average and we see a weaker profile (green line), which is part of the problem in interpreting short term/long term data.

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If we look more closely at the data and smooth out the month to month volatility (use a rolling average of the last six months data as opposed to pt to pt data) we find that employment growth in the private sector peaked in late 2014 and has been on a pretty consistent slide ever since. 

The following chart uses this smoothed data analysis and goes a step further by converting to monthly rates for Q, 6th monthly and annual percentage changes:

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Yep, we know that data goes in cycles even within an upswing, but underlying this data is a combined slowdown in global trade (recessionary conditions) and manufacturing as well as an imbalance between income growth and consumer credit.  The current slowdown looks to be eclipsing what might have started out as just an adjustment to heightened activity during mid 2014.  The manufacturing slowdown is illustrated in declining durable goods employment in the recent jobs figures:

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What does concern me though, with particular relevance to interest rate increases, is the make up of the jobs in the current recovery itself: note health care and social assistance employment which has been a major contributor to employment growth and its data profile remains strong:

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If we cross reference this with other data (note PCE ex Health care expenditure in GDP data) we see that consumer expenditure as a % of GDP has been flat lining since the end of the 1980s. 

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The increase in US employment post 2007 has been increasingly centred on health, retail and service sectors: for example healthcare and social services and the food and drink services sector combined account more or less for all the employment increase since January 2007:

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The trend towards service sector employment and greater service sector activity has been a long one and we need to be concerned over the income and productivity growth dynamics of the continuing divergence.

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I raise this question in the context of monetary policy, in particular the raising of interest rates to head off inflation driven by labour driven capacity constraints.  If a rise in interest rates is indeed warranted by employment figures which particular nail are we aiming to whack on the head? Definitely not manufacturing, and one would think not healthcare. But what about the retail sector and its employment?

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Quite possibly, especially when we consider that consumer credit growth has moved higher of late:

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Especially non revolving consumer credit growth and especially when we benchmark this to income growth:

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The following chart shows the relationship between consumer credit and PCE and PCE and income growth:

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Consumer credit is not only becoming more important and income growth less important, but growth in personal consumption expenditure is declining while the contribution of consumer credit remains elevated and trending up, which is not a good thing! Consumer credit as a % of PCE should skew upwards in recessions, but we are currently skewing upward in what should be a period of strong income growth, but is not!

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Represented graphically in a different way we find that the relationship between consumer credit, growth in PCE and income growth is deteriorating towards successive historical lows:

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Consumer credit growth is likely holding up retail and other service sector expenditure and is likely especially important to motor vehicles and parts sales:

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But even retail sales have hut a bump of late, although the short term trend itself looks to have stabilised in the last few months (consumer credit and employment growth):

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But once we look outside retail and health care we see weakness in areas previously exhibiting relative strength:

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Educational services is also on a declining trend:

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And even the relative recent rebound in non durable goods employment looks to be part of a weakening pattern:

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We remain in a secular funk with respect to employment growth: on a high water mark basis the growth in employment is more in keeping with post 2000 weak dynamics and less in line with the pre 2000 engine.

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In keeping with the above the last two economic cycles have been associated with slower population growth:

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Although interestingly the growth rate of the labour force has started to track population growth more closely which may imply a certain element of tightening in the market place. 

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A number of other key relationships remain out of alignment: part time workers relative to full time, self employed (incorporated and unincorporated) to employed…

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..and the employment to population ratio remains at lower levels as does participation rates:

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And discouraged workers still remains well above pre crisis levels:

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So we have relative strength in certain sectors supported by a steady increase in employment and growth in consumer credit.  The backdrop is weak domestic productivity and income growth, an unsettling composition of employment growth and global economic weakness, in particular a possible global trade shock centred in China.   The US is still growing slowly and while there are signs the labour market is tightening there is still considerable structural slack and remaining structural imbalances of concern. 

A rise in interest rates may well be needed in the light of growth in consumer credit, but I have concerns over the fact that wage growth has yet to ignite, that capital investment expenditure remains weak and that the Federal Reserve’s own views of economic growth potential may well be above that which the economy itself is able to produce.  Has the US economy returned to the normalcy envisioned by policy makers and with it its interest rate setting policy?  I think not, but I also feel that the divergence between income growth and consumer credit growth is a considerable problem and one that may come back to bite the US if China weakens further. 

Has demand moved to a level that would generate capital expenditure that many feel is necessary to push growth back to higher levels and would a rising interest rate scenario cut this particular and necessary part of the cycle short?  This critical intersect may be a key consideration in any interest rate decision.

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