Jobs growth is slowing, despite the big June gain

Despite a stronger-than-expected June gain of 191K private nonfarm payrolls (+191K vs +150K), private sector jobs growth—when measured over multi-month periods—has slowed from a Dec. '18 high of 2.3% to now as low as 1%. That's the weakest growth in over 8 years, but it's nothing to get worried or excited about. (Jobs data are notoriously volatile on a month-to-month basis, so you have to put more emphasis on multi-month trends. The June print may sound impressive, but it only extends this year's trend towards weakness.)

The slowing jobs growth that has emerged this year is neither a precursor nor a harbinger of a coming recession, so the Fed needn't feel any sense of urgency. Jobs growth is slowing not because the economy is slipping into a recession, but because some businesses are having trouble finding new workers and some are uncertain about the future given Trump's ongoing tariff wars. Slow-to-modest jobs growth combined with extensive evidence of low and relatively stable inflation (1.5 - 2.0%) and concerns that tariff wars could weaken the global economy add up to a justification for at least one rate cut, probably at the July 31st FOMC meeting.

Chart #1

Chart #1 shows the monthly changes in private sector payrolls (which are far more important than changes in government payrolls, since the private sector is the ultimate source of growth). Over the past six months jobs growth has averaged 169K, and in the most recent 5 months, gains have averaged only 134K (which latter translates into 1% annualized growth). Yet despite the recent weak growth of jobs, productivity has been running at roughly 2% per year of late, so jobs growth of only 1% can still result in overall economic growth of about 3%. With the Fed likely to oblige the market with another ease, there is little reason to worry that the economic outlook is anything but healthy.

Chart #2

Chart #2 shows the 6- and 12-month percentage change in private sector jobs. By either measure, jobs growth this year hasn't been this weak for over 8 years. The 5-month annualized growth of jobs has plunged to a mere 1%. Still, nothing to worry about. The economy's financial fundamentals are still quite healthy, as evidenced by very low swap spreads, low credit spreads, and abundant liquidity.

Chart #3

Chart #3 illustrates an under-appreciated fact about the current business cycle expansion: while private sector jobs growth has been impressive, public sector jobs have experienced a net loss. The ratio of public-to-private sector jobs has now fallen to 15%, which is the lowest it has been since 1957! (The ratio maxed out at 19% in mid-1975.) With public sector jobs flat in absolute terms but way down relative to the size of the economy, this gives the private sector some much-needed "breathing room" to continue expanding, if for no other reason than this: the public sector is not a serious competitor for the relatively scarce supply of available workers.

Chart #4

Chart #4 shows the number of part-time workers (blue line) and the ratio of part-time workers to total private sector employment. What stands out is the huge decline in the portion of the workforce that is working part-time. Full-time jobs have expanded at a much faster rate, and that points to a relatively healthy jobs market; businesses are confident enough in the future to seek out and hire full-time workers.

At least households are in good shape

The world is fixated on tariffs, weakened economies, China, central bank policies, low interest rates, high equity prices, and the possibility of a looming recession. Lots of things to worry about, and no one can confidently predict the future at this point. Too many variables, some of which are political. So I thought I would briefly change the subject and talk about the financial health of the household sector of the US economy, which is actually quite good. (all charts contain latest data as of Q1/19)

Chart #1

Chart #1 shows households' financial burdens, which are defined as monthly debt service payments as a percent of disposable income. This is a robust measure of debt burdens since it compares a flow (debt payments) to a flow (income). By this measure, households' debt burdens are at historically low levels, and have been for a number of years. No sign here of excessive borrowing, as there was prior to the past three recessions.

Chart #2

Chart #2 compares a stock (liabilities) to a stock (assets), and by this measure household leverage is as low as it has been since the mid-1980s.

Chart #3

Household net worth (Chart #3) has reached another all-time high: $109 trillion. This has been achieved primarily by increased savings and investments in both stocks and bonds. Home price appreciation has played only a minor role, since the value of households' real estate holdings has appreciated less than 20% since the housing price peak of 2006. At the same time, total debt has increased by only 10% since 2007. If only our government could be so frugal!

Chart #4

Chart #4 shows the inflation-adjusted value of household net worth, which has also reached an all-time high. It's important to note that this measure of financial well-being has been increasing by about 3.6% per year for many decades. Recent gains are almost exactly in line with historical experience. Nothing unusual or unsustainable about this.

Chart #5

Chart #5 shows the inflation-adjusted, per capita level of net worth, which is also at an all-time high ($329K per person). Note that this too has been growing at close to its long-term trend rate of about 2.3% per year. That growth rate is only slightly higher than the 2% annualized increase in labor productivity since 1950. That makes sense: living standards can only rise if we work harder and more efficiently, and that in turn requires investments of time and money (i.e., capital).

Chart #6

Federal debt owed to the public (currently $16.2 trillion) has been soaring by virtually any measure (see Chart #6). As a percent of GDP, federal debt is approaching 80%, the highest level since the early 1950s. It's worth noting that, contrary to what many might think, rising debt burdens do not necessarily translate into higher interest rates. If anything, there appears to be an inverse correlation between debt burdens and interest rates.

Chart #7

When compared to household net worth, federal debt has actually been declining for the past 6-7 years (see Chart #7). The current level (15%) may be high, but it's not beyond the range of believable: if we all wrote a check to the government for 15% of our net worth—a painful thought, but not a killer—federal debt would disappear.

Market to Fed: two rate cuts needed

We're in the midst of a mini-replay of the drama surrounding Fed policy that played out late last year and early this year. Back then the market was telling the Fed that it was mistaken in planning two more rate hikes this year, but it took the Fed a bit too long to figure that out, and that in turn led to a severe equity market selloff. But in the end they did figure it out, and they apologized to boot. Now the bond market is telling the Fed that at least two rate cuts are needed. They are needed to offset the increased uncertainties surrounding Trump's trade/tariff wars, which have now expanded to include Mexico, and the general malaise which has kept economy's growth potential from being fully realized.

Higher tariffs reduce future economic growth expectations and increase general uncertainty (e.g., what if tariff wars escalate further? what if China stumbles and brings down the rest of the world with it?). If the Fed fails to offset the increased demand for money this creates, then deflationary forces will take root and the risk of a recession (though still very low in my estimation) will increase.

Chart #1 

Chart #2 

In Chart #1 we see the significant decline in both nominal and real yields that has occurred since their November '18 peak. 5-yr Treasury yields have fallen over 100 bps, from 3.1% to 1.96%. 5-yr TIPS real yields have fallen by 80 bps, from 1.16% to 0.36%. Inflation expectations are down to 1.6%, but that could be largely due to the recent decline in oil prices, as shown in Chart #2.

Chart #3

Chart #3 compares the current real Fed funds rate (blue line: the difference between the Fed's target funds rate and the year over year change in the PCE Core inflation rate) with the market's expectation of what that real rate will average over the next 5 years (red line: the real yield on 5-yr TIPS). The message here is that the front end of the real yield curve is inverted, and that is a sure sign that monetary policy as it stands today is a bit too tight. Whereas the Fed says it is likely to stand pat for the foreseeable future, the market is saying they need to cut the funds rate target to 2% (vs the current 2.5%), and hold it there for the foreseeable future. The last two recessions were preceded by a similar inversion of the real yield curve (i.e., the blue line exceeding the red line), but the one important difference between now and the last two recessions is that real rates were much higher then than they are now. Red lights are flashing today, but this is not a four-alarm fire; it's more like the need for some modest adjustment to policy.

Chart #4

Chart #4 is the best chart to illustrate the impact of monetary policy on the economy. It combines the real Fed funds rate (blue line: the true "cost" of borrowing money) with the slope of the Treasury yield curve (red line: the difference between 1- and 10-yr Treasury yields). When the yield curve is flat or inverted and real interest rates are high, a recession has always followed. Today the yield curve is flat, but real interest rates are still relatively low. The current situation is problematic, but a recession is not imminent or foreordained. 

Chart #5 

Chart #5 is the classic way to look at the shape of the nominal Treasury yield curve, as measured by the difference between 2- and 10-yr Treasury yields. Here we see that the nominal curve is still somewhat positively-sloped. Again, a recession is not foreordained nor imminent. The market is sending a strong message to the Fed, and the market is betting that the Fed will respond accordingly.

Chart #6

If the Fed were really, really "tight," we would be seeing swap spreads rise, which would be an indication that liquidity conditions were deteriorating. Instead, we see swap spreads falling (see Chart #6). I interpret this to mean that the market is buying swap spreads in addition to Treasuries (pushing both yields down), in an attempt to hedge against the risks posed by Trump's tariff wars. We saw the same action in late 2015, when real GDP growth fell almost to zero. (That was also the time when oil prices collapsed from $100/bbl to $30/bbl, creating shock waves throughout the oil industry that threatened to spread to the rest of the economy.) The Fed is not really "tight" today, since they are not trying to restrict liquidity; they are simply keeping short rates a bit too high. The fundamentals of the economy are still sound, but the market is worried and so the market is paying up for bond-market hedges like swaps and bonds.

Chart #7

Chart #7 tells the same story. Credit Default Swap spreads have moved up a bit, but they are still relatively low. The market is only marginally concerned about the outlook for corporate profits. We're talking about a slowdown in growth, not a recession.

Chart #8

Chart #8 shows the market's expectation for what the Fed's target funds rate will be by the end of this year (as derived from Fed funds futures). From its high point of 2.93% last November (which implied two tightenings), the market now sees the funds rate target falling to 2% (which implies two easings). If the Fed doesn't get this message and act on it soon, then we might expect problems.

Chart #9

Finally, Chart #9 shows how the equity market is dealing with these issues. Fears (as measured by implied equity option volatility, or the Vix index) are up and growth expectations (as measured by the 10-yr Treasury yield) are down, which adds up to a moderate spike in the Vix/10-yr ratio. Equity prices have responded by falling, as they have during past "worry" episodes. The current episode is not yet of the significant variety, however. The Fed still has some time to react, but they shouldn't delay too long.