October: Another Strong Month for the Job Market

11/07/2014 |  Russell Price

October was yet another month of solid job growth as companies previously operating with very tight labor force levels are compelled to hire at a more rapid pace amid improving demand.

Previously, most businesses had excess capacity available to satisfy new order growth, but with hours worked very high and layoff activity very low, businesses have been getting just about all they can out of their current labor force levels. Simply put, businesses are at the stage where they have to hire or risk losing out on new sales. Improving consumer and businesses confidence levels also clearly help.

We had expected to see a stronger pace of hourly earnings growth by this stage, but we still feel that such gains are pending. Previously in this recovery, there was little reason for businesses to offer higher wages given the substantial slack available in the labor market. Now, with a lot of that slack removed, we believe it is just a matter of time before wages accelerate, assuming net job growth continues as we expect.  

Additionally, wage growth, combined with an expansion of hours worked in the month of October, produced a fairly solid 2.6% gain in average weekly earnings.  

The breadth of industries adding headcount over recent months is encouraging as it shows that the recovery is not reliant on just a few sectors benefiting from what could be temporary factors. The best recoveries are those that adhere to the "rising tide lifts all boats" adage.

Fed Policy

Further declines in the unemployment rate place greater pressure on the Federal Reserve to begin their tightening cycle sooner rather than later. But with signs of economic deceleration recently emerging in such key regions as Europe, China and South America, and the deflation pressures that have come with these scenarios, the tightening cycle could yet come later than the mid-2015 currently anticipated in the market. Overall, I don't believe today's employment data should significantly alter the market's expectations regarding Fed policy. 

For investors, the message of strengthening economic activity, and thus the likelihood of stronger corporate profit growth, should trump concerns over potentially sooner-than-expected Federal Reserve interest rate hikes. The interplay between economic growth and interest rates will remain a give-and-take, with interest rates unlikely to rise faster than economic fundamentals support. Overall, we believe interest rates, both Fed Funds and market based, are likely to rise at a modest pace over the next few years and it is likely to be a fairly manageable process - economically speaking.

Overall, we remain quite positive on the outlook for job growth. Businesses have been running with very tight labor force levels and even modest improvements in aggregate demand are necessitating stronger net new hiring. These hiring gains should likewise fuel additional consumer spending gains in the months and quarters ahead, thus further feeding into the economy's overall improvement cycle.

Details of Today's Employment Report:
  • Nonfarm payroll growth for the month of October was moderately weaker than expected (by 21,000) but the shortfall was more than made up by the net revisions to the prior month's data, which showed 31,000 more net new jobs created than previously reported. Wage growth, however, was a clear disappointment as we were expecting to see wage growth improve modestly as slack is further removed from the underlying labor market.
  • The unemployment rate also dropped to a new post-recession low of 5.8 percent. Though the implied message here is favorable, and we do believe the ranks of the unemployed are steadily declining, the current rate is misleadingly strong in our view. As we have noted in the past, the unemployment rate is derived from a separate survey (the Household survey) from the one that gives us nonfarm payrolls (the Establishment survey). Given that the household survey is significantly smaller, it experiences much greater month-to-month volatility. But more importantly, the unemployment rate is a function of the Labor Force Participation Rate (LFPR) which has been dropping, largely due to demographic trends. The Labor Department considers anyone over the age of 16 as potential labor force participants - not just those 16 to 65. As such, as our population ages and baby boomers retire at a faster pace, the LFPR has understandably been declining. A study from the Philadelphia Federal Reserve estimates that retirements are the most significant factor behind the falling LFPR over the last few years.
  • Wednesday's ADP report may have also given us a signal that the Labor Department report could be a little light. According to ADP, most of the job growth in October came from the small business sector. Given the nature of their business (payroll processing), we believe ADP has greater exposure to the small business community than the Labor Department's monthly survey of established businesses. We believe the nation's large businesses could have curtailed their hiring decisions temporarily amid concerns prevalent in late September /early October regarding European economic growth, capital market weakness, and even the Ebola fears that prevailed at the time. We believe any such hesitation that may have occurred is likely to be transitory.
  • Year-to-date, the American economy has generated 2.29 million net new jobs so far this year - the strongest pace since 1999.

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