Rising US average earnings growth casts doubt on the Federal Open Market Committee’s current assessment that “there remains significant underutilization of labor resources”.
Annual growth in average hourly earnings of production and nonsupervisory employees on private nonfarm payrolls increased to 2.5% in August, the highest since May 2010 and up from a low of 1.3% in October 2012.
In her Jackson Hole speech, Fed Chair Janet Yellen suggested that the FOMC is monitoring new composite measures of labour market conditions, constructed by using statistical methods to extract common information from a large number of indicators. Economists at the Kansas City Fed, for example, have created indices of the level and rate of change of labour market activity based on 24 indicators. The level measure has been trending higher since 2010 but remains 0.6 standard deviations below its historical average, consistent with the FOMC’s judgement of still-significant slack – see chart.
Such an approach, however, ignores possible structural shifts in the component indicators – the historical average may not be a good guide to “normal” conditions now.
The choice of indicators, moreover, is important: they should reflect all aspects of labour market behaviour. A notable omission from the Kansas City Fed activity measure is the job openings rate, i.e. the percentage of available jobs that are unfilled. This rose to 3.3% in June / July, matching the cyclical high reached in 2006-07, suggesting that employers now face significant difficulties recruiting suitable workers.
The job openings rate has been a better guide to wage pressures in recent years. Average earnings growth switched from a falling to rising trend in 2012 soon after the openings rate crossed above its historical average. The Kansas City Fed activity measure, by contrast, was 1.4 standard deviations below average in 2012. Nominal earnings expansion was above 4% in 2006-07 when the openings rate was last at the current level.
Faster earnings growth may contribute to the FOMC adopting less dovish language in its policy statement next week, supporting expectations of an interest rate increase in early 2015.
Japanese money growth remains weak but may be regaining momentum. Along with a fading impact of April’s sales tax rise, this suggests better economic performance in early 2015.
QE enthusiasts expected money growth to balloon in 2013-14, supporting a strong economy. A post in April 2013 explained that this was unlikely. Annual growth of broad money M3 was 2.5% in August, unchanged from March 2013, just before the Bank of Japan (BoJ) launched full-scale QE. Narrow money M1 expansion has been similarly static – 4.2% versus 4.1%.
Examining six-month rather than annual changes, M1 and M3 grew solidly during the second half of 2013 but slowed sharply from year-end – see first chart. With consumer prices boosted by April’s sales tax rise, the six-month changes in real M1 and M3 turned negative, warning that the economy was likely to disappoint forecasts – second chart. GDP fell by a much larger-than-expected 1.8% (7.1% annualised) in the second quarter and hopes of a strong third-quarter rebound have faded.
Six-month M1 and M3 growth, however, bottomed in July, recovering modestly in August. The sales tax rise, meanwhile, will drop out of six-month consumer price inflation in October. Real money growth, therefore, should resume this autumn, in turn implying a revival of economic momentum during the first half of 2015.
Currency-adjusted, US equities have outperformed Japanese stocks by 10% year-to-date, consistent with a large real narrow money growth gap in favour of the US in early 2014 – third chart. This gap is on course to narrow significantly, suggesting that the relative attraction of the US market is waning.
The global longer leading indicator* followed here rose in July, supporting optimism about near-term economic prospects.
The leading indicator fell between June and December 2013, correctly signalling an economic slowdown during the first half of 2014. Six-month industrial output expansion peaked in December 2013, falling through June 2014 – see chart.
The leading indicator rebounded strongly in early 2014 and has remained solid more recently. Industrial output growth recovered in July and should move higher through late 2014.
The indicator has been boosted by a rising emerging E7 component, suggesting that emerging-world economic news will surprise positively.
A post last week noted that global real narrow money expansion moderated between March and July, a trend that may have continued in August, judging from weaker US data. Real money typically moves slightly earlier than the leading indicator, and is less subject to revision. The central view here is that the global economy will expand solidly through late 2014 but slow in early 2015.
*Global = G7 developed plus E7 emerging economies. The indicator is derived by transforming and aggregating OECD country leading indicator data.
US narrow money rose strongly during the first half of 2014 but slowed in July and probably contracted last month, judging from weekly data through 25 August. Barring a strong September rebound, this suggests that the economy will lose momentum in early 2015.
Changes in real narrow money expansion precede economic growth fluctuations by about six months, according to the monetarist forecasting rule followed here. This relationship is strongest empirically in global data but is also informative at the country level.
Six-month growth of US real narrow money rose significantly between November 2013 and June 2014, suggesting strong economic performance during the second half – see previous post. Six-month industrial output expansion reached a 46-month high in July and July / August business surveys have been buoyant, with the new orders components of the ISM manufacturing and non-manufacturing surveys achieving their best levels since 2004 and 2005 respectively.
Monetary strength, however, reversed abruptly last month. Narrow money is likely to have contracted by about 0.75% in nominal terms, with six-month real growth falling to its lowest since November – see chart.
Monthly money supply changes are volatile and the August fall could be reversed in September. A bumper increase, however, would be required to push six-month real narrow money growth back up to its mid-year level.
Narrow money is held mainly for transactions purposes and changes usually occur ahead of spending variations, explaining its leading properties. US spending plans, in other words, may be turning more cautious, perhaps because of approaching Federal Reserve policy tightening.
Slower US real narrow money expansion suggests that the global measure tracked here will moderate further in August – see Wednesday’s post.
The UK 2008-09 recession may no longer warrant the label “great”. GDP is now estimated to have declined by 6.0% over five quarters in 2008-09 versus 7.2% over six quarters previously. The Office for National Statistics (ONS) has repeatedly claimed that the 2008-09 recession was the deepest in post-war history. This remains true – just – on the revised data: the 6.0% drop compares with a 5.9% reduction in the 1979-82 recession.
A comparison of the two recessions, however, should take account of North Sea oil and gas production, which rose in 1979-82 but fell in 2008-09, for reasons unrelated to the economic cycle. Excluding such production, the decline in output was marginally larger in 1979-82, i.e. 6.3% versus an estimated 6.2% in 2008-09 – see chart*.
Non-North Sea output, moreover, has risen by significantly more than overall GDP since the recession trough – an estimated 10.5% versus 9.3%. Output is still lower, relative to the pre-recession peak, than at the equivalent point in the 1980s but the shortfall is modest – an estimated 2.1% – and could easily disappear in future ONS revisions.
The new data suggest that non-North Sea output began falling in the third quarter of 2008, one quarter later than overall GDP, i.e. the onshore recession lasted four rather than five quarters. The later entry fits better with monetary developments: real narrow money started to contract in early 2008 and typically leads activity by about six months.
*Non-North Sea output is measured by gross value added (GVA) excluding oil and gas. GVA equals GDP minus the difference between taxes on production and subsidies. GVA ex oil and gas for 2007 Q1 to 2014 Q2 was estimated from the GDP revisions and previously published data.