Nothing's right, nothing's wrong for the Fed

A record rise in US payrolls could bring rate hikes forward if continued. But the separate unemployment survey shows a fall in participation and complicates the Federal Reserve’s outlook.

The unemployment rate is down to 6.3 per cent but the US shouldn’t get ahead of itself – its labour market still has a long way to go before rates will rise.

Non-farm payrolls rose by 288,000 in April, easily beating expectations, following solid gains over the previous three months. The monthly gain was the strongest since January 2012.

Despite concerns about job creation earlier in the year, and soft economic growth in the March quarter, non-farm payrolls are actually expanding at a faster pace than during 2013. The result was also supported by upward revisions to both February and March (up a combined 36,000).

Private non-farm payrolls rose by 273,000 in April, while the government created 15,000 new jobs. Services payrolls expanded by 235,000, while jobs in the goods sector rose by 53,000. Over the past year the service industry has accounted for over 85 per cent of jobs growth.


Graph for Nothing's right, nothing's wrong for the Fed

Government payrolls have been expanding for the past three months, with most of the growth centred at the local levels. Federal government payrolls continue to fall modestly, though with federal government austerity largely over that should begin to reverse soon.

The unemployment rate fell to 6.3 per cent in April, down from 6.7 per cent last month, to be at its lowest level since September 2008. But the US shouldn’t start popping champagne corks just yet – the fall reflects a decline in participation rather than job growth.

How is it possible to have solid payrolls growth and a misleading decline in the unemployment rate? It is a matter of survey design.

The payrolls and unemployment rate data are based on two separate surveys – the Current Employment Statistics (also known as the establishment or payrolls survey) and the Current Population Survey (also known as the household survey). The payrolls survey has a much larger sample size and in my view provides a better indication of conditions in the US labour market.

Over time the two surveys provide a similar picture of the US labour market but from month to month they can show vastly different results – April was one of those times. I’m putting more weight on the payrolls data but we shouldn’t ignore the unemployment and participation rates.

The decline in the unemployment rate was directly matched by a 0.4 percentage point fall in the participation rate. This largely reflects retirements and discouraged former workers giving up on the workforce. Had the participation rate remained unchanged in April then the unemployment rate would have instead remained at 6.7 per cent.


Graph for Nothing's right, nothing's wrong for the Fed

Much like Australia, the US has experienced a sharp decline in the participation rate since the global financial crisis began. The participation rate has declined by over 3 percentage points since July 2008 and is at its lowest level in 35 years.

The participation rate is expected to trend lower over the next decade as the ‘baby boomers’ retire; however, I wouldn’t be surprised if it picked up a little as conditions in the US economy improve. Some discouraged former workers are likely to find employment as conditions improve and with the economy expected to grow at a strong pace over the rest of 2014 that could begin as soon as this year.

With millions of discouraged workers waiting for an opportunity, there remains considerable spare capacity across the US economy. The labour market is certainly not as tight as an unemployment rate of 6.3 per cent suggests. It is also why wages and inflation remain so subdued.

Job creation in April – and upward revisions for February and March – should put to rest concerns that momentum slowed significantly in early 2014. However, the labour market isn’t expanding at a sufficient pace to rapidly reduce the number of long-term unemployed or to create wage pressures. Inflation is likely to remain benign into 2015.

From a rates perspective, the Federal Reserve is unlikely to be persuaded by a strong payrolls number or a volatile unemployment rate. It will certainly be buoyed by the pick-up in job creation but will recognise the decline in the unemployment rate for what it is – retirements and the unemployed giving up.

The most likely scenario for rates remains a hike in 2015 – though if this pace of payrolls growth continues then Americans could be facing an early 2015 hike rather than a rise later that year. By that stage the taper of the Fed’s asset purchasing program should be long over, with the Fed all but certain to continue cutting purchases when it meets again in June.