Three Things to Keep in Mind for Friday’s Employment Report

The February jobs report was a killer: 313,000 new jobs were created, with an additional 54,000 in upward revisions.  Average hourly earnings growth, however, was much less impressive, growing only 2.6% YoY and just 0.4% after factoring for inflation. So, despite the unemployment rate holding at 4.1%, companies are hiring briskly but wage growth is mysteriously absent. Looking ahead to the March employment report due on Friday, April 6, there are number of items to look for:

1) Total Labor Income: A Holistic Look at Labor Markets

The Bureau of Labor Statistics (BLS) reports labor market data in a fairly atomistic fashion.  Unemployment is calculated from a household survey. The number of jobs created is presented as a month-on-month change from a survey of establishments. Average hourly earnings are usually presented as a year-on-year change.  The number of hours worked are a monthly series and remains largely overlooked.

When we evaluate the March 2018 data (or any other employment report), we prefer to standardize these measures by looking at the change in non-farm payrolls and number of hours worked as a year-on-year percentage change. This way it lines up with the percentage change in average hourly earnings. More importantly, it allows us to calculate total labor income, which is the total number of people working multiplied by the average number of hours multiplied by their average hourly earnings.

Total Labor Income = Number of Workers X Average Hours Worked X Average Hourly Earnings

This is a much more comprehensive view of labor market conditions than looking at non-farm payroll data by itself and obsessing over whether it was a few tens of thousands of jobs more or less than expected in an economy that employs over 148 million people. Figure 1 shows that the growth in total labor income looks like overtime as well as the growth in its individual components.  Basically, since 2010, its been growing very consistently at around 4%.  In the past several months it’s been slightly but not alarmingly above that trend at around +4.4% year on year.

As the labor market has tightened, a few subtle shifts have happened within the labor market.  Despite February’s strong employment gains, overall, the pace of hiring has slowed moderately.  In 2014, the total number of people working grew by 2.2%.  In recent months that growth rate has come down to around 1.4-1.6%.  As the labor market has tightened growth, average hourly earnings have perked up but again, not by much.  From 2010 until 2015 they rose at around 2% per year.  Starting early 2016 they accelerated to around 2.6% year on year.  They remain well below the 3.0-3.5% pre-crisis pace.

Figure 1: Total Labor Income is a More Meaningful Way of Looking at Job Market Conditions.

Figure 2: Plunging Unemployment = Only Mild Upward Pressure on Wages.

2) How Low Can Unemployment Go?

There has been a great deal of discussion as to why wage growth hasn’t improved more substantially even as unemployment has declined.  Is it because of technological advances and workforce globalization weakening labor bargaining power?  Are wages not growing faster because of the rise in “on demand” work such as driving for ride-hailing companies which now employ over 750,000 people in the U.S. alone?  While these questions are interesting, this paper takes a narrower approach and seeks to answer the question, how much further can unemployment fall in the current economic cycle?  Could we see 3.5% unemployment?  3.0%?  2.5%? 

It’s a remarkably difficult question to answer in part because it isn’t purely a function of labor economics; it’s also a question of monetary policy.  On the face of it, the labor market could probably tighten much more significantly without generating runaway inflation.  If wage growth accelerated from 2.0% to 2.7% as unemployment dropped from 5.0% to 4.1%, would it accelerate to around 3.4% if, say, unemployment falls another 20% from 4.1% to 3.3%?  Would 3.4% wage growth be inflationary?  At the height of the previous economic expansion, 3.0-3.5% wage growth hardly set off a 1970s-style price spike.  One could argue that strong productivity growth kept a lid on inflation in 2006 and 2007 but, in truth, productivity was growing only about half a percent faster than in 2017.

Irrespective of the lack of inflationary pressure, the Federal Reserve appears determined to tighten policy a great deal further.  Already it has raised rates six times and begun to shrink its balance sheet.  If its ‘dot plot’ chart is to be believed, the Fed will hike rates two or three more times in 2018 (possibly three more times) and three times in 2019 and twice in 2020.  On top of that the Fed is also likely to accelerate the pace at which it shrinks its balance sheet. Not surprisingly, the rate hikes that have taken place thus far have dramatically flattened the yield curve.  If the Fed follows through on its forecast pace of rate hikes, by the end of 2019, the yield curve will likely be flat. 

Flat yield curves often spell trouble for economic growth.  The past five recessions were all preceded by flat or inverted yield curves (Figure 3).

The good news is that the yield curve is not yet flat enough to cause a downturn in the economy and an upturn in unemployment.  As such, it seems highly likely that the U.S. economy will continue growing throughout 2018 and probably 2019 as well.  Even if the yield curve is flat or inverted by the end of next year, unemployment might continue to fall well into 2020.  So, how much lower can it go?  The past three cycles offer some insight. 

Figure 3: Flat/Inverted Curves Precede Recessions.

The 1980s: in some ways the current economy resembles that of the 1980s.  In 1982, unemployment peaked at 10.8%, not far from its 2009 peak of 10%, and subsequently fell by half; the government ran enormous budget deficits and productivity growth was mediocre.  There were many differences as well: inflation was higher and more erratic than it is today, averaging 4.5% over the course of the expansion and varying from 1.1% to 6.2% YoY.  Also, interest rates (both real and nominal) were much higher than they are today. Those differences aside, so long as the yield curve averaged around 200-250 basis points (bps) or more in steepness, the unemployment rate fell – much as it would during subsequent economic expansions including the current one.  What is instructive for economic forecasters in 2018, is that when the yield flattened below a 200-bps difference between the 30-Year yield and 3-Month rates, the unemployment rate pretty much stopped falling.  During the last few years of the economic expansion, unemployment stayed in a tight range from 5.0-5.4% before a recession eventually set in beginning in June 1990. 

The 1990s: As one can see in Figure 4, the 1990s began looking a great deal like the 1980s.  Unemployment fell a great deal in 1993 and 1994 amid extremely steep yield curves.  There were other similarities, too.  Budget deficits remained large in the early 1990s and productivity growth was slow. There were some differences, too.  Unemployment didn’t peak as high as in 1992 as it had in 1982: 7.8% versus 10.8%, and inflation decelerated to around 2% following the 1990-91 recession and remained not only low but surprisingly stable.

Figure 4: Big Declines in Unemployment Happened with Steep Curves.

In 1994, the Fed hiked rates from 3% to 6%, eventually lowering rates back to 5.25% in 1995 as the economy slowed.  Unemployment stabilized around 5.5% in 1995 and 1996, much as it had in 1988, 1989 and early 1990.  Then something completely unexpected happened.  Productivity boomed, keeping a lid on inflation and allowing the unemployment rate to fall a great deal further, coming down below 4% for a bit in 2000.  The economy grew quickly despite relatively flat yield curves, perhaps in part as a result of the wealth effect generated by the 250% rise in the equity market between 1995 and 2000. 

Even the surging 1990s economy couldn’t withstand a flat yield curve forever.  In 1999 and 2000, the yield curve averaged around 50 bps in steepness between 3M and 30Y and in 2001 the economy slipped into a relatively mild recession that took unemployment from 3.8% to 6.5% (Figure 5).

The lesson from the 1990s is that if we have a productivity revolution, unemployment could fall a great deal further without sparking an inflationary spiral upward.  Even with unemployment at 3.8% in 2000, core CPI rose at only about 2.6% YoY – a bit higher than it is now but hardly alarming.  It makes one wonder if the Fed really needed to raise rates as high as 6.5% in 2000, and stifle the recovery.

Figure 5: The Curious Case of the ‘90s Goldilocks Economy: Soft Landing + Productivity Revolution.

Since 2004: When the two-year moving average of the 3M-30Y yield curve got to around 200 bps in 2006 – close to where it is today — unemployment was close to 4.7%.  As the yield curve continued to flatten, unemployment fell further but only slightly, eventually drifting down to 4.4% by early 2007.  This pretty much resembles what happened during the 1980s.  As such, barring a productivity revolution, and given the current pace of Fed tightening, unemployment may be close to the bottom.  So maybe 3.8% is the most that we can hope for on the downside unless the Fed relents and dramatically slows its pace of tightening (Figure 6).

That said, the Fed’s pace of tightening is only about half as fast as what it was doing between June 2004 and June 2006.  During that period, the Fed raised rates at every meeting for a total of 17 times.  This time the Fed is going to move at every other meeting at most, and aiming for three (or maybe four) rather than eight hikes per year.  As such, perhaps unemployment can fall further towards 3.5% or below before the Fed muffles the expansion and possibly sends the economy back into another recession.

Figure 6: Unemployment Might Stabilize Around 4% for a Year or Two Until the Fed Tightens Too Much.

The question though is why is the Fed raising rates so aggressively when even at 4.1% unemployment inflationary pressures are mysteriously absent?  Does the Fed really think that higher inflation is just around the corner?  Will unemployment at 3.5% or below trigger wage and consumer price inflation?

3) Where is inflation and what is the Fed really doing?

Inflation has been curiously absent for decades during periods of both rising and falling unemployment, recession and expansion.  In fact, the Phillips Curve, calculated over the period from 1994 to present is nearly flat.  The logarithmic line of best fit shows inflation averaging around 1.5% during periods of 10% unemployment and around 1.8% during periods of 4% unemployment.  Projecting outward, it suggests that if unemployment fell by half to 2%, inflation would average around 2.2% (Figure 7).  So why doesn’t the Fed leave monetary policy loose and let it keep falling? 

Figure 7: Why Not Let Unemployment Fall Further?

One answer may be that the Fed thinks that higher inflation is just around the corner and that there will be a sharp rise in inflation should the labor market tighten further – one that can’t be forecast on the basis of the relationship between unemployment and inflation when unemployment exceeds 4%.  Another answer might be intellectual indolence and inertia.  During past tightening cycles the Fed had often raised rates until a calamity (the savings and loans crisis in 1989 and 1990, the stock market crash in 2000, the real estate market and stock market collapse in 2006 and 2007).  Along those lines, a third possibility is that what the Fed is really doing is targeting asset prices.  Maybe the Fed is worried that equity prices are getting too high and that if they keep rising anywhere like their 2009-2017 pace, a massive asset bubble might develop and when if it blows up, the Fed might be blamed.  

If the Fed is targeting asset prices, it would be interesting to know because asset prices are outside of their statutory objectives of maximum employment, stable prices and moderate long-term interest rates.  The Fed appears to have achieved the latter two: prices appear to increase at about the same pace no matter what they do, and long-term rates are certainly modest, if not at moderate levels.  The one variable in their mandate that does not appear stable is employment, which has been a wild ride over the past few decades with a floor seemingly around 4%.  Beyond their statutory mandate, asset markets are also unstable, with the market cap of the S&P 500® having risen from 40% of GDP to 120% since 2009 (Figure 8).  As such, it begs the question, will the Fed sacrifice further gains in employment not to control the non-existent problem of consumer price inflation but rather to control the hypothetical problem of highly valued markets?   Its task will also be complicated by growing budget deficits and trade skirmishes which may also influence the growth rate of total labor income and inflation.  Stay tuned.  The Fed’s actions, not its words, will provide the answers to these questions.

Figure 8: Are Asset Prices and Not Consumer Prices or Wage Inflation the Fed’s Real Concern?

Bottom line

  • Total labor income is a much better indicator of the labor market than average hourly earnings or nonfarm payrolls taken individual and out of context.
  • The unemployment-yield curve relationship suggests that unemployment may be within 0.3% to 0.6% of hitting bottom and that the low in unemployment could be around 3.5-3.8% in the current cycle unless the Fed eases up on its tightening cycle.
  • Once the yield curve becomes flat, it is likely that unemployment will begin to rise.
  • Since 1994, the relationship between the level of unemployment and the yield curve has been extremely weak. This suggests that the Fed could allow unemployment to fall significantly further before consumer price inflation becomes a significant risk.
  • The Fed’s current tightening cycle may be better explained by concerns over asset prices and a desire to be able to cut rates in the event of a recession than any real concerns about runaway consumer price inflation.


All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

About the Author

Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.

View more reports from Erik Norland, Executive Director and Senior Economist of CME Group.

Jobs Report and Equities

U.S. employment reports are closely watched by investors for their ability to impact financial markets, and the report due on Friday, April 6, will be no different. Fine tune your exposure with a highly liquid portfolio of equities and options products on the benchmark S&P, NASDAQ-100, and Dow indices from the CME Group.

Trade Now