Expectations that wage growth would slow were dashed inside the U.S. jobs report for November as average hourly earnings increased by 5.1% on a year-ago basis and by 0.6% on the month in addition to being revised higher in October.
The Fed will need to lift its policy rate above 5%─perhaps as high as 5.5%─before entertaining any idea of a pause.
The primary policy takeaway from the report is that the Federal Reserve will need to lift its policy rate above 5%─perhaps as high as 5.5%─before entertaining any idea of a pause in its efforts to restore price stability.
The chance that the Fed can engineer a soft landing for the economy has narrowed and supports our forecast of a mild recession next year.
The November jobs data, which showed an increase of 263,000 jobs and an unemployment rate of 3.7%, is just the latest sign that Fed policy needs to move into restrictive terrain to prevent a wage-price spiral.
Wage growth is going to be sticky, and the notion of wage push inflation demands a policy response to create the conditions where wage growth is closer to 3.5% in contrast with the above-5% pace that is currently the case.
It is almost certain that when the Federal Reserve’s summary of economic projections is released in two weeks, it will feature a policy rate above 5% in its dot plot forecast of interest rates.
Normally, a top-line gain of 263,000 jobs─the economy needs to generate only about 65,000 to meet basic demand─and an unemployment rate of 3.7% (3.655%) would be cause for celebration.
But this gain occurred as the labor force participation rate fell for the third straight month, hitting 62.1%, and as the employment-to-population ratio stood at 59.9%.
Given the increase in wages, one would think that workers would be drawn into the labor market. But that is not happening in the current economic expansion.
The combined long-term demographic trends of an aging workforce and lower immigration, along with the impact of the pandemic, are causing an acceleration of structural change in the labor force.
Federal Reserve Chairman Jerome Powell, in the question-and-answer period following a recent speech, talked of the impact of a surge in retirements as the baby boomers exit the workforce and the debilitating effects of long COVID-19. Those two factors combined are likely contributing to between 2 million and 4 million missing workers in the labor force.
The evolution of the jobs data supports this idea, and will affect both wages and overall inflation. When the November Consumer Price Index is published on Dec. 13, the focus will be on the pace of inflation for services ex-housing, which Powell pointed out as being particularly sensitive to wage inflation.
We will be closely monitoring that metric as negative base-year effects, or comparisons to a year ago, bring down top-line inflation even as wage and service inflation proves sticky.
The data
The top-line increase of 263,000 in the establishment survey was tempered by a decline of 138,000 in the household survey and an overall decline in the labor force of 186,000.
The major source of gains was in education and health care, which added 82,000 positions in November; leisure and hospitality, which added 88,000; and government, which added 42,000.
The job gains in the government sector were all at the state and local level. Given the broad sell-off in the equities markets this year, which will cause capital gains tax revenues at the state level to decline, the recent pace of job gains at the state and local level is not sustainable.
The private sector gained 221,000 jobs, while private service-providing jobs increased by 184,000. Higher-paying goods-producing jobs advanced by 37,000 positions, construction jobs increased by 20,000 and there were 14,000 more manufacturing jobs than there were in October.
The information sector grew by 19,000 jobs, the financial sector by 14,000 and professional business services by 6,000.
In the trade and transport sector, there was a net decline of 49,000 jobs, the retail sector shed 30,000 workers and temporary help hiring declined by 17,000.
Overall aggregate hours worked declined by 0.2%, and the median duration of unemployment stands at 8.4 weeks.
The takeaway
The labor market remains tight and overheated. Competition for labor inside a workforce that is shrinking supports higher wage gains, which are feeding into elevated inflation across the economy and inside the service sector.
While there is now evidence of residual weakness inside some areas of the economy and noticeable job losses in trade, transport and retail, it is being more than offset elsewhere.
More important, we have made the case for some time that the American labor market is undergoing structural change that will result in a tight labor market for the foreseeable future. With that shortage of workers will come upward wage pressure that will contrast with relatively staid wage increases during the past few business cycles.
