Before the outbreak of hostilities in the Middle East, the American economy was in strong shape, with brisk spending, positive manufacturing sentiment and overall stable labor conditions.
The March employment data released on Friday reaffirmed that trend as hiring sharply rebounded with 178,000 new jobs while the unemployment rate declined to 4.3% (4.256% taken to three digits).
Wages grew by 0.2% in the month, which resulted in a 3.5% increase from one year ago.
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While the top-line figure was impressive it overstates the true underlying trend in hiring because of changes in the birth-death model that will result in volatility from month to month inside the Bureau of Labor Statistics’ monthly report.
That change in turn demands that one take a smoothed three-month look at hiring which results in a 68,000 per month increase. That level is more than sufficient to keep labor conditions stable and is well above the 50,000 jobs needed each month to maintain stability.
It is important to note that the wage growth inside the monthly jobs report is estimated on a nominal basis and is not adjusted for inflation.
As the top-line inflation caused by the oil shock shows up in the data, that means at best a slowing in real wage growth if not an outright decline, which will dampen consumption and overall economic activity in the second quarter.
Policy implications
The Federal Reserve will and should remain on hold until clarity on the impact of inflation and unemployment because of the war as well as the direction and duration of the conflict can be ascertained.
While we are certain that top-line inflation over the next two monthly reporting periods—April and May—will show sharp increases, dampening real wage growth and consumption, policymakers will focus on pricing expectations and any potential bleed into core inflation.
Various Federal Reserve officials, including Chair Jerome Powell, made the point this week that long-term inflation expectations remain well anchored.
Although that is true, the Fed is also keen to avoid the policy error made during the pandemic, which involved ignoring shorter-term inflation expectations that pointed to non-transitory inflation.
The wage data inside the monthly employment estimate is reported on a nominal basis. Central bankers will interpret declining real wages as a risk to growth amid a sustained period of soft labor demand, and not as a potential source of second-round effects that result in sharp increases in wage demands by workers that would result in persistent inflation.
That is why the focus on inflation expectations remaining well anchored will be key until one gets a sense of the direction and duration of the conflict.
The data
The percentage of people in their prime working years of 25 to 54 who are employed stands near a cyclical high of 80.4%, which is indicative of the underling health of the labor market.
The February data was affected by weather and a health care strike. Inside the March data, 35,000 people went back to work, which is part of the 76,000-job increase in health care jobs.
In addition, there was a 26,000 increase in construction jobs following the 13,000 declines in March. Goods-producing jobs increased by 43,000, while manufacturing saw an increase of 15,000.
The private service sector saw an increase of 143,000 jobs, driven by a 33,000 increase in trade and transport, a 10,000 advance in retail trade, 2,000 in professional business services and 4,000 in temporary help. There was a decline of 15,000 jobs in financial service hiring and a 3,000 drop in information workers.
The leisure and hospitality sector added 44,000 jobs in March while government workers dropped by 8,000.
Total private hours eased to 34.2 hours worked with a decline in overtime of 0.3%. Aggregate hours worked eased to 116.2. The labor force participation rate eased to 61,9% as did the employment-to-population ratio of 59.2%. The median duration of unemployment increased to 11.5 weeks.
The takeaway
Our interpretation of the strong rebound in hiring in March is that it is more noise than signal.
Methodological changes to the monthly estimate of the birth-death model have injected volatility into the data, and we think that the three-month average of 68,000 jobs created is a better representation of demand for labor and the underlying trend in monthly hiring.
Nevertheless, that figure was more than sufficient to keep American labor market conditions stable and was enough to cause a decline in the unemployment rate to 4.3% in March.
While the economy and labor market was remarkably solid on the eve of the war in Iran it is important to note that as the oil shock results in inflation, that upward pressure on prices will slow real wage growth which in turn will dampen growth in the current quarter.
The key question is if the supply shock that is currently working its way through the U.S. economy will dampen wage growth at best or result in an outright decline, which would affect growth and hiring.
