The dissonance in jobs
This week has seen Gavekal senior partners reach a rare consensus of sorts, with Anatole Kaltesky acknowledging that May’s “pig ugly” US payrolls report upped the chances of Charles Gave’s US recession scenario playing out. For me, the report offers a classic mixed signal: on the one hand the slowdown in US employment growth could stem from firms dialing back hiring in anticipation of trouble ahead, or alternatively it could be the result of a tight labour market at the end of a long expansion. As such, we may have reached a point of dissonance in the business cycle when a better indicator than the headline payroll number is needed.
To explain why, it may be useful to break the report down using the simplified distinction of firms offering goods and services to consumers, and firms serving businesses. Companies selling to US consumers should have no problem making their payrolls as spending remains robust—US real personal consumption growth was 3% YoY in April, which is not surprising as households have healthy balance sheets and seem happy to borrow. As such, non-farm consumer services payroll growth remains strong at 1.44 mln YoY, just below its 20-year high of 1.5 mln. Payroll growth for consumer goods’ makers is also robust by historical standards. Going forward, any slowdown in net hiring among consumer-focused firms will likely stem from insufficient supply of labour.
On the other hand, the elevated level of the US dollar means that business goods’ producers have sharply slowed hiring to the point that on a YoY basis, this sector is close to contraction territory. This situation reflects US producers’ loss of competitiveness and a broad-based build-up of inventory. As their profitability shrinks, US producers have no choice but to cut capital spending. Indeed, real nonresidential fixed investment contracted YoY for the first time since the 2008 crisis at -0.5% in 1Q16. Any firm which relies on such US capital spending will likely have shrunk its demand for labor and this trend is likely to persist a good while longer. In addition, the commodity price collapse has pushed many raw material producers to the verge of bankruptcy, as reflected in shrunken mining and logging payrolls. The blowback from the commodity unwind has also hit transport services as demand for coal and other energy shipments has collapsed.
A good question is thus whether the diverging outlook between the “consumer” and “business” facing sectors of the economy renders the headline non-farm payroll data useless as an indicator of US economic health—at least at this point in the cycle. After all, it can perfectly logically be argued that the reading is consistent with a late-stage business cycle expansion, or the start of an economic collapse. At this point in the cycle, when the employment market is inevitably subject to dissonance, it may make more sense to monitor job openings rather than hiring. The logic is that in a bust scenario, job openings would inevitably fall, while in a tight labor market situation, job openings should remain solid. For now, the NFIB job opening index shows the US corporate sector demanding more workers, which is consistent with a “tight labour market” thesis especially as wage growth remains decently strong. In this view of things, it is not surprising that Janet Yellen offered a fairly upbeat view on US economic prospects on Monday, and with them the chance for future rate hikes.