Putting July’s job numbers into perspective

Or, why the Fed should not raise interest rates in September.

The BLS reported that 255,000 jobs were added in July. The New York Times ran a story quoting Michelle Meyer of Bank of America Merrill Lynch saying, “This was everything you could have asked for, maybe more.” The unemployment rate held steady at 4.9 percent, and wage growth has finally picked up a bit, growing at 2.6 percent year over year. After years of nominal wage growth that barely kept up with inflation, 2.6 percent represents real gains, if only just so.

The underlying threat to any good jobs report over the last few years is that the Federal Reserve will potentially overreact and raise interest rates prematurely, just as the recovery is gaining steam, and despite constant threats to recovery from a tumultuous world. I am not in the Fed prediction business, but prior to the release of the report, Fed watcher Tim Duy stated that July’s FOMC meeting was really just laying the markers for a showdown between hawks and doves in September, and with July data now in hand, a good jobs report may make it untenable to push off on raising rates again. September may be the month interest rates go up to 0.50%.

Why do I worry that the Fed raising rates in September is premature?

It’s true that job growth was strong in July. And it’s also true that the unemployment rate stands at 4.9%, which might normally be considered full employment, which is the unemployment rate where people think things can’t get much better without inflation spiraling upwards.

But, there are a few charts and data points that better describe the status of the labor market than the headline unemployment rate, and they show that the recovery from the greatest recession since the Great Depression is still far from complete, and that there is no sign of inflation getting out of control. The downsides of not raising rates, then, are minuscule compared to the downsides of raising rates, which could harm the still fragile and incomplete recovery.

The headline unemployment rate doesn’t count a lot of people who have exited the labor force: if the jobs just aren’t there, people don’t look, and thus aren’t included in the relevant denominator of the calculation. The BLS thankfully calculates an alternative measure: the unemployed (those actively looking for work but not employed) as well as those who are part-time for economic reasons, plus those who are “marginally attached” to the workforce. This latter category includes those who are available for work, but who didn’t bother looking for various reasons, including the belief that there were no jobs available.

fredgraph1

U-6 Unemployment Rate

 

As of July of 2016, this expanded-definition unemployment rate stood at 9.7%, much higher than the troughs in the previous economic expansions at 7.9% in December of 2006 and 6.8% in October of 2000. The usual suspects argue that this is structural: that there is a mismatch of skills, and that this is just the new normal. But these people were wrong at the start of the recovery, and there are few reasons to believe they are right now.

The employment-to-population ratio for ages to 25 to 54 is another metric that is more informative than the headline unemployment rate. This “prime-age” ratio captures employment in the part of the population you’d like to see employed. It captures similar trends to what we saw in the expanded unemployment rate: again, we see an incomplete recovery:

 

fredgraph2

Employment to Population Ratio, 25-54 Years

 

The peak in the prior economic expansion was 80.3%, and we are still at 78.0%. There’s clearly been improvement, but there’s also still quite a bit of ground to make up. A back-of-the-envelope calculation shows that if an employment to population ratio of 80% represents full employment, and the estimated population ages 25-54 stands at about 125 million, then we are still short 2.5 million jobs.

I hopefully have convinced you that there’s still considerable slack in the job market. Is inflation the metric that is then pushing the Federal Reserve to raise rates?

Various measures based on the consumer price index (CPI) make it hard to think inflation is getting out of control. I plot a few here for reference:

fredgraph3

16% Trimmed-Mean and Median CPI

Median CPI and 16% trimmed-mean CPI, both intended to get at the momentum or inertia of inflation without being affected by volatile outliers like food and energy, show 2.2% and 1.9% inflation, respectively, in June of 2016. This is right around the Fed’s target (and one could argue the target is far too low).

So: inflation is right around the 2% target, and there’s still significant slack in the labor market. What, then, is the hurry?

 

 

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