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Job growth accelerated in the United States in May, although it remained below analyst expectations. More than half the jobs created were in the leisure and hospitality sector. Participation in the labor force declined while employment increased. The result was a sharp decline in the unemployment rate. Investors greeted the jobs report favorably, pushing up equity prices while pushing down bond yields. They evidently saw the report as an indication of continued strong economic growth but mild inflationary pressure. Let’s look at the details.
The US government produces two reports on the job market—one based on a survey of establishments, the other based on a survey of households. The establishment survey found that 559,000 new jobs were created in May, far more than the upwardly revised 278,000 jobs created in April, but less than the 785,000 jobs created in March. While this is up about 12 million jobs from a year earlier, it remains about 7.6 million jobs below the prepandemic level of February 2020. Thus, the job market remains somewhat depressed.
The manufacturing sector saw 23,000 new jobs, entirely due to job growth in the automotive sector. Meanwhile, construction employment declined sharply, likely reflecting shortages of key inputs as well as skilled labor. The construction industry has long relied on migrant workers from Mexico. Cross-border movement of labor has been severely disrupted by the pandemic.
As for employment in services, 292,000 jobs were created in the leisure and hospitality sector, less than in April but more than in March. This included 186,000 jobs at restaurants and bars, 35,000 at hotels, and 72,000 at arts, entertainment, and recreation facilities. This surge reflected the reopening of the economy across the country as well as greater confidence owing to increased vaccination. In addition, there were 87,000 new jobs in education and health services. However, the retail sector saw a net loss of almost 6,000 jobs, including a 26,000 decline in jobs at grocery stores. This likely reflected the shift of consumer spending away from meals at home and toward restaurants. Even large general merchandise stores saw a decline of nearly 5,000 jobs. However, clothing stores boosted employment by more than 10,000, possibly indicating that people are increasingly concerned with their appearance now that they are going out again. Also, because there continues to be growth of online commerce, employment in transportation and distribution increased by 23,000. Finally, employment in state and local governments increased by 78,000, possibly due to the impact of stimulus money provided by the Federal government.
The establishment survey also provides data on average hourly wages. It found that the May average hourly compensation was up 1.9% from a year earlier, a relatively mild number. However, there were big differences by industry. Compensation was up 6.1% in financial services, even though employment in the sector was stagnant. Compensation was up 4.3% in retail, possibly indicating a struggle to attract people to work in stores. And compensation was up 3.7% in the thriving leisure and hospitality sector that’s working hard to ramp up capacity. That said, compensation was up only 1.0% in manufacturing. The overall modest boost to wages suggests that the economy is not yet facing the kind of wage-price spiral that would ignite sustained inflation. Thus, it is no wonder that bond yields fell following release of this report.
The separate survey of households indicated that, although the working-age population grew by 107,000 in May, labor force participation fell by 53,000. Participation means people who are either working or actively seeking employment. The decline suggests that some people became discouraged because of a skills mismatch. Meanwhile, employment grew strongly. The result was that the unemployment rate fell from 6.1% in April to 5.8% in May, the lowest level in 14 months. The unemployment rate among those aged 16 to 19 fell dramatically, indicating the likely return of younger workers to the retail and hospitality sectors. There was also a sharp decline in the number of people unemployed for more than six months.
The relatively moderate pace of job growth, combined with limited wage gains, suggests that the Federal Reserve is likely to leave monetary policy unchanged. The decline in participation suggests continued reluctance on the part of some potential workers to engage in the labor force. When, later this year, children go back to school and daycare full time, it is possible that many hesitant workers will reenter the labor force. If herd immunity is reached later this year due to mass vaccination, those fearful of the virus will likely return as well. Plus, once supply-chain disruptions are resolved, businesses will be in a better position to boost hiring further. Thus, there are reasons for optimism. On the other hand, another surge in infections later this year could set the clock back substantially. Experts in the field of public health have said that this is not a trivial risk, especially in states with low rates of vaccination and high rates of mobility and social interaction.
Despite an elevated unemployment rate and the number of employed being 7.6 million below the prepandemic level, it appears that the US job market is relatively tight. For example, the National Federation of Independent Businesses says that 44% of businesses surveyed report having job openings that they are unable to fill. This is the highest percentage in the history of the survey. The number of online advertisements for jobs has surged, especially for those jobs that involve interaction with people.
Meanwhile, many businesses are boosting wages and offering signing bonuses in order to attract reluctant workers. While some people are reluctant to work because of enhanced unemployment insurance benefits, this clearly does not apply to jobs that offer decent compensation. Instead, a survey by the US Census Bureau found that, in March, over six million people were not looking for work because they were caring for children who were not in school or daycare. Another four million were fearful of catching or spreading the virus.
The hope is that, by September, most children will return to school and daycare and a sufficient share of the population would have been vaccinated to make fear of the virus a thing of the past. There is, however, no guarantee that this will be the case, especially given continued vaccine reluctance on the part of many people.
Another factor causing a tight job market is demographics. Many older workers have chosen to drop out of the labor force, given concern about the virus. The participation rate among those over 65 fell dramatically in the past year. At the same time, the number of young entrants to the labor force has been low compared to the number who have exited. Older households have seen a surge in the value of their assets, including homes. They have also boosted saving in the past year. Thus, many don’t necessarily see the need to work, given their favorable financial situation.
What does this labor shortage mean for inflation and for Federal Reserve policy? The President of the Federal Reserve Bank of St. Louis, James Bullard, said, “I’m evolving toward a judgment where labor markets should be interpreted as fairly tight, and you’re certainly seeing that in firms saying that they’re just going to go ahead and raise wages for these types of workers. They’re going ahead and saying, ‘let’s pay some signing bonuses to get to get workers in the door,’ you’re seeing some businesses actually just staying shuttered because they can’t find enough workers.” However, he indicated that he was not yet ready to think about changing monetary policy, at least not until the pandemic was truly over. If wages do indeed accelerate sharply due to labor shortages over a long period of time, this could be inflationary. However, if the wage gains are offset by productivity gains due to implementation of labor-saving technology, then unit labor costs will be stable and inflation will not be a problem. Moreover, the shortage of labor could abate soon if the pandemic ends, children return to school, and workers gain confidence.
Labor productivity is measured as the ratio of output to hours worked. In recent years, productivity growth in the United States has been modest. Yet as the US economy comes out of the pandemic, productivity is increasing rapidly, in part a reflection of the shift in the types of work taking place and the mix of skills and capital being used. The government reports that, in the first quarter of 2021, labor productivity grew at an annualized rate of 5.4% over the previous quarter. This reflected an increase in output of 8.6% and an increase in hours worked of 3.0%. Quarterly changes are often volatile, which has been especially true during the pandemic. Thus, it is useful to look at the change from a year earlier. The government reports that, in the first quarter, productivity was up 4.1% from a year earlier. This reflected a 1.1% rise in output and a 2.9% drop in hours worked. To put these numbers in a prepandemic perspective, productivity grew 1.7% in 2019, with output up 2.4% and hours worked up 0.7%.
Why do we care about productivity? One answer is that, in the long run, it drives economic growth—and consequently, growth in the size of the labor force. If productivity rises faster, the economy will grow more rapidly. Another answer is that productivity can influence the level of inflation. That is, if wages increase rapidly, but are offset by productivity gains, then the labor cost of producing a unit of output would not increase, thereby not requiring any price increase. This brings us to unit labor costs (ULC), which is a measure of the labor cost of producing a unit of output. The change in ULC is measured by dividing compensation growth by productivity growth. If wages rise faster than productivity, then ULC rises and inflationary pressures are present—and vice versa.
The latest data shows that, in the first quarter of 2021, ULC was up at an annualized rate of 1.9% from the previous quarter. It was up 4.1% from a year earlier, reflecting an 8.3% increase in hourly compensation and a 4.0% increase in productivity. This suggests the possibility of inflationary pressures. However, the much slower rate of quarterly increase suggests that ULC pressure is abating. Moreover, the surge in compensation from a year earlier partly reflects a shift in the mix of jobs. That is, there are fewer lower-paid workers in retail stores and more high-paid workers in technology companies. Thus, the average compensation has increased accordingly, but not necessarily because of general inflationary pressure. Finally, to put things in their prepandemic perspective, it is worth noting that ULC increased 1.9% in 2019, a year during which there was low inflation. In the quarters to come, it will be interesting to observe the trend in these numbers in order to better gauge the degree of inflationary pressure and the likely speed of economic growth. For now, the numbers are too volatile to draw robust inferences.
The weakness in the global economy in the past year was mainly due to a decline in activity in the services industry. The necessity of avoiding social contact led consumers to shun restaurants, bars, theatres, airplanes, hotels, and other venues that involve interaction with other human beings. The global economy will only return to the prepandemic path once services fully recover. The good news is that this is starting to happen in key parts of the world.
The latest purchasing managers’ indices (PMIs) for services were released by IHS Markit and they indicate rapid expansion of the services sectors in the United States and Western Europe, healthy growth in China, and declining activity in India and Japan. Overall, the global PMI indicates rapid global growth in services. PMIs are forward-looking indicators meant to signal the direction of activity. They are based on sub-indices such as output, new orders, export orders, employment, pipelines, pricing, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth—and vice versa.
The global PMI for services hit 59.4 in May, a 15-year high and a number indicating very rapid growth in activity. This was driven by strength in new orders, business sentiment, and a surge in input prices. The most stunning report was from the United States, where the services PMI jumped from 64.7 in April to 70.4 in May, a record high. This was driven by a record increase in output and new orders. The continued reopening of the economy as well as consumer confidence, driven by increased vaccination and reduced rates of infection, helped to propel the sector. This led to a surge in input prices due to shortages of key supplies. Employment growth in the sector was strong, but likely held back by reluctance of some people to return to work.
In Europe, the services PMI for the United Kingdom increased from 61.0 in April to 62.9 in May, the highest in 24 years. United Kingdom’s reopening had a big positive impact as did the strong pace of vaccination. As elsewhere, the surge in activity led to a surge in input prices, creating new inflationary pressures. In the Eurozone, the services PMI increased from 50.5 in April to 55.2 in May. This meant that, after stagnating due to economic restrictions, the lifting of restrictions led to an acceleration in activity. There was a big increase in new orders, backlogs, and employment. Service activity grew especially strongly in Ireland, Spain, and France. Growth was slower in Germany.
In Asia, the picture was not as spectacular as in North America and Europe. India’s services PMI fell sharply, from 54.0 in April to 46.4 in May, indicating a decline in activity. This reflected the sudden closure of businesses due to the massive outbreak. In contrast, growth in China remained steady and strong with the PMI at 55.1 in May. Finally, Japan’s services PMI fell from 49.5 in April to 46.5 in May, indicating declining activity, likely due to new economic restrictions meant to stifle the virus.
Going forward, the health of the large services sector will be determined by the rate of vaccination, the rate of infection, the easing of travel restrictions, and the willingness of consumers to interact with other people. It will also be influenced by the ability of businesses to quickly boost capacity through hiring. It might require significantly higher wages and/or investments in labor-saving technology.
It is increasingly clear that the European Central Bank (ECB) does not intend to scale back asset purchases any time soon. Some analysts had begun to question whether it makes sense for the ECB to change policy. This discussion was driven by the expectation of faster economic growth this year as well as rising inflation in the Eurozone. These factors have already led to an increase in bond yields. However, the expectation of a shift in policy was dampened this week when several leaders of the ECB indicated that it is not yet time to adjust policy. For example, Fabio Panetta, a member of the ECB executive board from Italy, said, “A premature withdrawal of policy support would risk suffocating the recovery before it becomes self-sustained. From my viewpoint, the conditions that we see today do not justify reducing the pace of purchases.” He added, “We should not extrapolate from what is happening in the United States. We don't expect the same kind of surging demand and tight labor markets that would generate stronger lasting price pressures." The US Federal Reserve has left policy unchanged. However, it did indicate amenability to shifting policy sometime in the future. Canada’s central bank, however, has started to ease asset purchases. Meanwhile, ECB President Lagarde said that it is “far too early” to discuss longer-term issues for the Eurozone.
In response to the comments by Panetta and Lagarde, bond yields in Europe fell. The yield on the German government’s 10-year bond fell four basis points in one day after a month of rising. Yields on bonds issued by France, Italy, and Spain fell by a similar amount. The extent of the decline in yields reflected, in part, investor surprise at the ECB commitment to maintain asset purchases. Given the evident strengthening of the Eurozone economy and the rise in inflation, many investors had expected a different attitude on the part of ECB leaders.
Meanwhile, breakeven rates in the Eurozone indicate an increase in expectations of inflation in Europe. First, the breakeven rate is calculated by subtracting the yield on an inflation-protected security from the headline yield. In the case of an inflation-protected security, the principal moves in line with inflation. As such, the yield is the real (inflation-adjusted) return on the bond. The difference between the two yields is, therefore, the expected rate of inflation.
In Germany, the 10-year breakeven rate was 0.48% a year ago. It then reached 0.91% in early January. Now it is 1.4%—even though the headline yield on the 10-year bond remains below zero. Thus, the real (inflation-adjusted) bond yield is substantially negative. This is likely due to continued massive bond purchases by the ECB. That policy, along with expectations of a robust economic recovery, explains the rise in inflation expectations.
Meanwhile, the breakeven rate in the other major economies of the Eurozone has moved roughly in line with that of Germany. For example, the 10-year breakeven rate for Italy increased from 0.381% a year ago, to 0.849% in early January, to 1.36% now—slightly lower than that of Germany. The lower expectation for inflation in Italy than Germany reflects an expectation that the German economy will be stronger in the coming years, with less slack in the labor market. The headline yield in Italy, 0.96%, means that the real rate, while negative, is substantially higher than that of Germany. That partly reflects a perceived higher risk of default in Italy. Finally, the 10-year breakeven rates in France and Spain are currently 1.36% and 1.47%, respectively. Thus, most investors have relatively consistent expectations about inflation across the Eurozone. In all cases, the expectation remains below the ECB’s target rate of inflation of 2.0%. Meanwhile, the 10-year breakeven rate in the United States is around 2.4%, higher than the Federal Reserve’s target of 2.0%.
The Chinese renminbi has appreciated recently, hitting a three-year high against the US dollar, having risen about 10% in the past year. The increase reflects relatively high bond yields in China, which have generated strong inflows of portfolio foreign investment. It also reflects expectations that China’s economy will grow strongly in the coming year, with high returns on portfolio assets. The Chinese authorities are concerned that a higher valued renminbi will hurt the competitiveness of Chinese exports, especially at a time when the profitability of many of China’s smaller manufacturers is at risk. That, in turn, is due to the rise in the cost of imported commodities. Global commodity prices have surged due to a rapid expansion in global demand, combined with supply chain constraints as global companies struggle to adjust to a new normal.
Although the renminbi has risen in value, the rise has been constrained by the fact that the central bank places limits on how far the exchange rate can move. Recall that a senior central bank official recently called for allowing the currency’s value to be fully determined by market forces. However, such flotation of the currency does not appear to be in the cards. Liu Guoqiang, deputy governor of the central bank, recently said that there are no plans to change the exchange rate regime. He said that the managed floating exchange rate is “an institutional arrangement fit for China at present and in the foreseeable future.” Even if China intended to float the currency, it would likely not say so at this time. Meanwhile, in order to prevent a larger appreciation, the central bank must engage in purchases of foreign currency.
China’s central government is strongly considering introducing a national tax on residential property. This is a controversial issue. Many local governments oppose this move as they expect it will result in lower property prices. Local governments often rely on property sales to generate revenue. So lower property values would be a problem for them. At the same time, experimental property taxes introduced in Shanghai and Chongqing did not, evidently, result in a decline in property prices. Rather, property prices continued to rise due to reduced land sales and an easy monetary policy.
There are two major reasons why a property tax could make sense. First, it would generate a reliable stream of government revenue, eliminating the need for unpredictable property sales. Second, it would encourage economically sensible use of land and would discourage the kind of speculative purchases that are currently popular. It has been widely reported that there is a very large number of unoccupied homes in China. One reason is that people purchase newly built unoccupied homes as a speculative investment, hoping that the value will eventually rise in the long term. Given the low yield on bank deposits and the casino-like quality of equity markets, property is seen as a favorable and reliable investment. Yet massive construction of unused property is a waste of resources and is environmentally damaging. A property tax would discourage this kind of investment. It would enable a shift of resources toward investments that have a positive return in the short term.
One problem is that, in China, people own their homes but not the land on which they are built. Instead, all land is owned by the government and is leased to homeowners on a long-term basis. While some critics worry that this will create a problem in implementing a property tax, there are several countries in which the value of homes is taxed even though the land is owned by the government. This is true in Singapore, for example.
The path of personal income and consumer spending in the United States over the past year has been volatile, largely due to the periodic dispensation of government stimulus payments. April was no exception. The US government reports that, after a sharp increase in personal income in March due to the massive US$1,400 payments made to about 85% of Americans, personal income fell sharply in April, returning to a normal level. However, after a big increase in spending in March, spending stabilized in April at a high level. Thus, it is clear that the stimulus payments continued to have a positive impact on economic activity. Meanwhile, although the savings rate fell in April, it remained historically high. The volume of money saved by American households over the past year is massive and possibly sets the stage for a further revival of spending on services later this year, provided that the country continues to have success in quelling the COVID-19 outbreak.
Here are the details. After rising 20.9% from February to March, total personal income fell 13.1% from March to April. Notably, wage income was up a robust 1.0% in April as employment and wages continued to rise. However, government transfers fell 41.4% after having risen 95.2% in the previous month. After accounting for inflation and taxes, real disposable personal income was down 15.1% from March to April. However, real consumer spending fell only 0.1% from March to April after having risen 4.1% in the previous month. In other words, after rising sharply to a new plateau in March, spending stayed roughly at that level in April as consumers dipped into the money they had saved in the previous month. In fact, the savings rate fell from 27.7% in March to 14.9% in April, roughly where it had been in February. The data on consumer spending is consistent with data on retail sales that was released earlier.
As for categories of spending, Americans spent less on goods and more on services. Specifically, real (inflation-adjusted) spending on durable goods fell 0.9% from March to April, spending on nondurable goods fell 1.6%, and spending on services increased 0.6%. This implies, for example, that households spent less at grocery stores and more at restaurants. People are going out again, fueled by a reduction in economic restrictions and fewer mask mandates. The number of new infections is down sharply and, although the rate of vaccination has slowed, the share of the population that is fully vaccinated is higher than in most other developed nations. Still, the threat of new variants remains.
The latest report on personal income included data on the personal consumption expenditure deflator, which is the Federal Reserve’s favorite measure of inflation. While not as dramatic as the recent consumer price index report, it did indicate an acceleration in inflation. Specifically, the report noted that the deflator was up 0.6% from March to April and was up 3.6% from a year earlier. Excluding the impact of volatile food and energy prices, core prices were up 0.7% from March to April and were up 3.1% from a year earlier. In addition, the greatest annual inflation was seen for durable goods and the least was for services. This is consistent with the surge in demand for durable goods and the supply chain constraints in meeting that demand.
There was no new information in the report on inflation. Consequently, bond yields fell following the report on inflation. If investors had been surprised by the high level of inflation, yields would have increased. Most investors evidently appear comfortable with the Fed’s analysis that the increase in inflation is temporary and related to transitory factors that will abate by next year. The next big piece of news will be the May employment figures which will be released one week from today.
For much of the pandemic, spending on consumer-facing services, such as restaurants, has been suppressed in the United States, keeping economic activity below the prepandemic path. For many months, there was an expectation that, once a large number of people are vaccinated, there will be greater confidence that the virus is less of a threat and that, as a result, spending on consumer-facing services would rebound strongly. We now have evidence as to what is happening. Indeed, spending on consumer-facing services is up as consumer mobility has increased. And yet this revival cannot be explained by vaccination. In fact, evidence suggests that, in states with relatively low rates of vaccination, mobility has increased significantly faster than in states with higher rates of vaccination.
Specifically, a survey conducted by Cardify revealed that, in April, spending at entertainment venues increased 20% since January for consumers reporting no intention of being vaccinated. For those intending to be vaccinated, the increase was only 10%. In addition, Cardify found that, in states with greater vaccine reluctance, visits to airports and hotels was 71.2% of the prepandemic level in April. In states, with more vaccine enthusiasm, the number was 52.7%. Cardify found other examples in which mobility and spending increased more for vaccine-reluctant consumers than for vaccine enthusiasts. How can we explain this anomaly?
One possible explanation is that people are less likely to be vaccinated or intend to be vaccinated in states that opened earlier and that have removed mask mandates. In those states, it is likely that consumers are less fearful of the virus than in other states, leading to a greater degree of mobility and spending. This explains what has happened in recent months, but might not explain what will happen in the months to come. In fact, as vaccination proceeds, the overall level of fear will likely diminish, perhaps leading to strong growth of mobility and spending in states that, heretofore, were home to a larger number of immobile consumers.
Interestingly, the pattern found by Cardify is consistent with political affiliation. That is, the states with more vaccine reluctance and faster increases in mobility are largely those that supported Donald Trump in the 2020 election. Meanwhile, states with greater vaccine enthusiasm and slower increases in mobility tended to support Joe Biden. For many months, political affiliation has been strongly correlated with attitudes toward vaccination.