A slow US recovery lurches forward

The US economic recovery remains intact although the trajectory to full health and full employment is uneven.

The market, somewhat surprisingly, was a little spooked with the latest US jobs report that showed ‘just’ 88,000 new jobs in March although the more measured assessment was to look at the strong and upwardly revised increase in job creation in February to get some context to the momentum in the labour market and a truer picture of the strength of the US recovery.

Average monthly job gains in the last three months have been just under 170,000, almost exactly the same as the average gain in the last 12 months as a whole. Clearly, there is no loss of momentum and next month we are likely to see a further 170,000 plus jobs increase.

Rather than concern about the recovery faltering, as some fear, the jobs data confirm that the damage inflicted on the US economy because of the banking and housing crisis was so severe that it will take a lot of time to repair. No one seriously thought the speed to recovery would be much faster than it currently is and there are many who thought it would be slower, so to that end, there are grounds for ongoing cautious optimism.

The US economy and its labour market are still clearly a long way from returning to normal. Recall that around 8.7 million jobs wiped out during the crisis and the working population has grown over the past five years which means that the run rate of job creation needs to be strong for a long time, probably another three or four years, before the economy is back at full employment.

Including the latest March data, there have been around 5.9 million jobs created from the low point in the employment cycle three years ago which, allowing for changes in participation rates and other demographic factors, means there is still an output gap for employment of around 5 million people. 

There is no doubt that it will take several more years before policy makers can be content that the wreckage of the crisis has been fixed and that most of the spare capacity in the labour market has been reduced to acceptable levels.

The unemployment is still uncomfortably high at 7.6 per cent and would be higher were it not for the sharp falls in the participation rate that have been evident on recent years. The current unemployment rate remains a long way from the intermediate target of the Federal Reserve of 6.5 per cent which is why Fed Chairman Ben Bernanke will keep interest rates near zero for a few more years and why quantitative easing will remain in place a little bit longer.

The US jobs data also reconfirmed that financial markets are in a strange place. US stocks remain close to record highs, notwithstanding the small fall on Friday. If one was relying on the stock market for a guide to the pace of economic growth over the next six months or so, there would be grounds for optimism.

The US bond market, conversely, is seemingly priced for ongoing economic hardship, with the yield on the 5 year government bond currently at 0.69 per cent while the 10 year yield fell to just 1.71 per cent in reaction to the jobs data.

The reason why the stock market at the moment is more likely to be a reliable guide to the growth prospects than the bond market is that bonds are heavily distorted by central bank intervention.

The Fed holds close to $3 trillion of bonds, including close to 30 per cent of all the 10 year government bonds on issue. Its quantitative easing strategy has seen it buying bonds at a rapid pace and in the process distorting the market by deliberately pushing yields artificially lower. This is the critical reason why the lead from the bond market is not reliable.

The most recent down leg in bond yields followed the extraordinary monetary policy easing from the Bank of Japan last week, a move that will flood global markets with the equivalent of US$600 to $700 billion a year to further throw a red herring into bond market analysis.

The end point is that the US economy continues to recover, jobs are being created, the unemployment rate is falling and monetary policy will continue to be easy for a long time to come or at least until the slackness in the jobs market eases further. At the same time, the stock market remains strong which is a good indicator that the real economy will continue to pick up, albeit at an uneven clip.