Everything is coming together for the US labour market.
On Friday, we learned that the economy added 280,000 jobs in May, more than Wall Street economists had forecast. What’s more, this report showed that the amount of jobs added in April and March were also revised higher by 32,000, bringing the average job gains over the last 3 months to 207,000.
But the biggest part of the report on Friday, however, was that at long last we are seeing wage growth.
Worker wages grew by 0.3% in May compared to the prior month and rose 2.3% over the prior year. The year-on-year increase was the most since October 2009 and shows the final piece of the labour market puzzle is being filled in.
In a note to clients following the report, Deutsche Bank economist Torsten Sløk wrote, “This is what we have been waiting for since 2009. In other words, the virtuous cycle has begun.”
Why wages matter
Right now, markets are concerned about one thing: The Federal Reserve.
Markets expect that before the end of 2015, the Fed will raise interest rates for the first time since July 2006. The latest Fed Speak from New York Fed president Bill Dudley affirmed this view, and while markets don’t expect the Fed to do anything at its next policy meeting on June 16-17, the July and September, most market participants see the Fed raising rates before the end of this year.
The Federal Reserve, for its part, is trying to fulfil its dual mandate of price stability and full employment. Currently, the Fed is targeting 2% inflation and projects the labour market will be at “full employment” when the unemployment rate is at 5.1%.
But these are just projections.
What the Fed really needs to see is wage growth, as more money in the pockets of American workers and consumers has been the missing ingredient since the financial crisis.
And so while the Fed expects that with the unemployment at 5.1% the economy will be facing inflationary pressures, perhaps the unemployment rate at which inflation begins to take is somewhat higher. Friday certainly suggests this might be the case.
Part of why the unemployment rate rose on Friday despite the stronger-than-expected job gains is that more people joined the labour force, with the labour force participation rate rising to 62.9%.
And so this increase is actually an encouraging sign for the labour market. People who are out of work and looking for a job are considered part of the labour force, and much of the decline in the labour force participation rate over the last several years was attributed to workers dropping entirely out of the workforce. But with an increase in labour force participation, not only are people actually working, but people are now trying to find work.
In addition to the increase in the labour force participation, there was also a noted decrease in the number of discouraged workers — defined as those out of the work force and want a job but aren’t trying to find one — in May.
And so while outright job gains and wage increases are the kinds of top-line things economists and policy makers want to see in the labour market, these lesser-watched indicators showing that Americans are simply less downbeat about their job prospects are the signs of a robust labour market.
On Friday, bonds sold off as markets took Friday’s labour market as a sign of potential Fed tightening to come. For the last several years, betting on Fed inaction with respect to interest rates has been a winning trade.
But as wages increase and job gains remain solid, this time, at least for Fed policy, might actually be different.