Payrolls rose by 295,000 in February and the unemployment rate fell to 5.5% in an unambiguous show of strength by the labor market. The strong payroll gains suggest the US economy continues to power ahead and the labor market continues to drive this growth. Less robust were the wage data, which showed that average hourly earnings of private-sector workers rose by 2% in February from a year earlier.1 That is in line with similar gains made over the past four years.
There is evidence that wages are rising in the service sector, which is not impacted by the dollar rally. But they are being held back in the manufacturing portions of the economy, which would be impacted by dollar strength and commodity weakness. Virtually flat wage growth means that even February’s strong employment gains may not change market expectations of when the Federal Reserve is likely to raise interest rates.
The graph below illustrates this labor market dynamic: Growth in manufacturing wages has declined while service sector wage growth is on the rise. Ultimately, we at Invesco Fixed Income expect the export sector to stabilize and rising service wages should help drive overall wage growth higher. Notably, many of the service jobs with the highest wage growth are lower paying. A substitution effect of lower-paying jobs for higher paying jobs may be holding back average hourly earnings in aggregate.
Service Sector Jobs Beating Manufacturing in Terms of Wage Increases
Even with wages relatively steady, healthy job growth improves the chances that the Fed will meet its 2% inflation target, in our view — the sharp rally in the US dollar and falling oil prices have raised concerns. Despite commodity price weakness and global disinflationary pressures, we believe the US is on track to grow around 3% this year, and the Fed is still on track to raise interest rates by mid-year. Once the Fed begins its rate-hiking cycle, we believe the strong growth trend in the US is likely to lead to a faster pace of rate increases than the market is expecting.
Today’s jobs data confirm several of Invesco Fixed Income’s macro views: There is likely to be continued divergence in economic performance between the US and other major economic blocs in Europe and Asia. Signs of improved expectations of growth are emerging in Europe, but it is still too early to determine if real economic growth is taking hold. Global economic and policy divergence is likely to support a continued rally in the US dollar — the US dollar reached new highs in light of today’s employment report, rising over 1% versus the euro after the announcement. As this divergence and sharp rally in the US dollar continues, tighter liquidity conditions may cause credit stress among riskier assets including emerging markets, and may lead to potential credit events.
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