What shutdown what slowdown

Between the U.S. Federal Reserve (Fed) meeting on Wednesday and today’s jobs report, investors have had quite a bit of news to digest this week. 

This had all the makings of a quirky jobs report for a number of reasons: The government shutdown could've created noise in the data, it’s January and there has been a polar vortex (we economists love blaming things on the weather), and minimum wage increases in 17 states went into effect this month. And then there's the annual benchmarking exercise: Every January, the Bureau of Labor Statistics adjusts its numbers by using actual employment data from 97% of businesses as reported in their weekly filing with state unemployment insurance agencies. In the end, the jobs report was very strong, albeit with a few puzzles:

• 304,000 jobs were created last month, and although December’s figure was revised down (to a still impressive 222,000), the three-month average for nonfarm payroll increases was 241,000 jobs added per month—an astoundingly high rate for this stage of the business cycle.¹    
  
• The unemployment rate ticked up to 4.0%, partly as a result of a higher labor force participation rate, which ticked up to 63.2%, the highest since 2013.¹ Every time we think we’ve run out of people to pull off the sidelines into the labor force, we find more. It goes to show that most economists don’t really know what they’re talking about when they talk about labor market “slack.” It’s like the dark matter of economics, the source we attribute things to that we can’t otherwise explain. 
• Unemployment probably also ticked up because of the government shutdown. Because furloughed government workers will receive back pay, they’re counted in the establishment survey; there was no impact from the shutdown on wages or sector-specific jobs. The household survey, which is the source for determining the unemployment rate, is a different story. People are asked in these surveys about their work situation and furloughed government workers have historically had a hard time explaining what their work situation is. So, as was the case with the government shutdown in 2013, some people end up giving the impression that they’re unemployed in the surveys even though they aren’t. This is noise that won’t be a part of the data next month.
• Average hourly earnings (AHE) grew by 3.2% year-over-year. Low-wage, low-hour sector wages were boosted in part by the hike in minimum wage in 17 states. There’s a calendar bias in the data that pushes AHE up slightly every December and then moderates again every January.¹    
  

1. The good news is that we added more jobs in high wage, high hour sectors like construction, manufacturing, trade, utilities, and transportation. This should be positive in terms of pulling AHE up. But the bad news is that wages in some of these sectors fell. Why is a bit of a mystery.
2. If the economy is slowing and the job market continues to run hot, then economic theory says that productivity growth has to be weakening. But if wage growth is accelerating (even if only moderately) and inflation is weakening (again, moderately), then economic theory says productivity growth has to be accelerating. So what gives?

If the Federal Open Market Committee (FOMC) had been this week instead of last, I don’t think Jay Powell would've adopted quite the dovish tone that he did. Policymakers should never extrapolate based on one data point, but the fact is that the labor market continues to roar. The Fed will get much more data before its next FOMC meeting and this week’s jobs report will probably have largely been forgotten by then.

That being said, Powell highlighted at the last FOMC meeting press conference a number of crosscurrents to justify the Fed’s capitulation to the markets—slowing Chinese growth, slowing global growth, tighter financial conditions, the government shutdown, and Brexit. China is leaning on banks to lend to the private sector and giving them the liquidity to do so and has provided around $500 billion in fiscal stimulus measures so far. The Purchasing Managers’ Index (PMI) data still looked awful today, but the aggregate credit data is starting to turn² suggesting the stimulus measures (that started six months ago) are starting to hit the real economy—one of the benefits of having a centrally planned economy! I expect China will stabilize in the first half of this year and will see growth accelerate in the back half, which would certainly help German and Japanese growth. So there are two crosscurrents potentially off the front burner.

Meanwhile, financial conditions have already eased in January as equity markets have rebounded (overcorrecting to the upside, perhaps). The government shutdown shouldn’t be an issue in the second half of the year. That leaves Brexit on the table as a continuing challenge later this year, but Powell was quick to highlight that Brexit is a second-order issue for the United States. The Fed also mentioned that inflation pressures are now muted. To be fair, inflation pressures have been muted for most of this cycle, with maybe a slight deviation this past summer due to a number of one-off statistical quirks. I think come midyear, we’ll be having a very different conversation about the Fed’s path forward, and that the Fed has paused rather than scrapped any plans to hike again in this cycle.

There’s no doubt that the Fed has had a rough transition from forward guidance to data dependency. I think during the second half of the year, the data will ultimately justify a rate hike—if not two.

1 Bureau of Labor Statistics, as of 2/1/19. 
2 Caixin/Markit Manufacturing Purchasing Managers’ Index (PMI), as of 2/1/19.