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Analysis

U.S. Employment Report: Entering the Second Half of the 'Year of Two Halves'

By Christian Menegatti and Prajakta Bhide

EXECUTIVE SUMMARY

Good economic news is too much to ask for these days. The U.S. employment report surprised to the downside, not so much because of the expected negative headline following the Census layoffs, but rather because of the fall of both weekly hours worked and average hourly earnings, as well as weaker-than-expected payroll gains in the private sector (83,000 versus the 110,000 expected by the Bloomberg consensus). The workforce contracted for the second month in a row with a sharper 652,000 drop in June, contributing to another 0.2% reduction of the unemployment rate. Unemployment and underemployment remain stubbornly high, and we maintain the view that  the unemployment rate will peak only in early 2011. Personal consumption was a growth driver in Q1 2010, as we predicted in our most recent Outlook. But over time, growth in consumption will become more aligned with income growth, which remains rather anemic, given that both weekly hours worked and average hourly earnings fell. Substantial slack is still present in labor markets after the economy shed over 8 million jobs during the recession, and this will prevent any wage pressures from rising. We are more confident than ever in our theme of a "Year of Two Halves"—with downside risks to our 2% real GDP growth prediction for the second half of 2010.

See the details of the report in the RGE Critical Issue: U.S. Labor Market: Private Hiring Lukewarm, Hours and Earnings Fall

The Good News

  • The private sector continues to create jobs. After some strong private job creation in March and April (an average of 200,000), May disappointed with only 33,000 private jobs created. Private hiring was better in June with 83,000 jobs—still a bit short of the 110,000 consensus.

The Almost Good News

  • Although employment fell, the sharp fall in labor force (not necessarily good news) brought the unemployment rate down to 9.5%. The U-6 underemployment rate (which includes workers who have part-time positions but want full-time positions as well those who have given up looking for work) remains very high but also fell back only marginally to 16.5% from the previous 16.6%. As we expected, the materialization of job creation triggered a job hunt that boosted the total the labor force by a whopping 805,000 in April. Then, we witnessed a somewhat worrisome correction in May with 322,000 people leaving the workforce. The correction was even more pronounced in June: The workforce contracted by 652,000. Discouraged people are leaving the workforce again. We remain worried about the effects of persistently high unemployment rates on consumption. RGE expects the unemployment rate to peak at 10.1% in Q1 2011.

The Bad News

  • Headline numbers were negative, but that was expected as Census hiring turned into Census firing. Non-farm payrolls fell by 125,000 in line with consensus. For more details, see the RGE Critical Issue: U.S. Labor Market: Private Hiring Lukewarm, Hours and Earnings Fall
  • The change in private payrolls came in a bit weaker than hoped: 83,000 jobs were created versus the 110,000 that consensus expected. This is considerably below the 200,000 average job creation in March and April.
  • The household survey echoed and outpaced the establishment survey, showing an ugly 301,000 jobs lost. The drop is bigger than can be explained solely by Census firing. Indeed, the household survey reported a 166,000 decline in private sector employment. The survey includes self-employed workers, part-time workers and small businesses, which are not captured by the BLS survey. Until recently, the household survey was lagging the establishment survey, but it showed strong job gains starting in January 2010—a positive sign that has clearly reversed in the last two reports.
  • The average workweek and temporary employment are leading indicators for the labor market since firms increase work hours, hire temporary workers and move workers from part-time to full-time before hiring new full-time workers. The economy continues to add workers albeit at a slower pace—20,000 in June versus 30,000 in May—and temporary employment has risen 192,000 so far in 2010. The bad news is that the average workweek fell to 34.1 hours after reaching 34.2 hours in April. The workweek in the manufacturing sector fell back as well, down to 40 hours (back to March) after reaching 40.5 hours in May. This is not good for income generation.
  • Even worse for income generation, average hourly earnings month over month fell 0.1% against an expected positive 0.1%. Additionally, so far, 882,000 jobs have been added in 2010 (private payrolls have risen by 593,000) and at this pace it will take five years just to recover the over 8 million jobs lost during the recession.
  • The median unemployment duration continued to increase in June 2010, rising to 25.5 weeks—a series high from 23.2 in May. Over 45.5% of unemployed workers have been jobless for six months or more. There is little to alleviate concerns about the deterioration of human capital.

  • The diffusion index of employment continued to fall in June. It fell to 52.2 from 54.8 in May and 68 in April. Since an index value of 50 indicates a balance between industries cutting jobs and industries adding jobs, the June number certainly falls in the bad news category, as it suggests that payroll gains are less broad-based than in previous months.

Outlook

Clearly this was a weak employment report. This is not encouraging as the recovery is failing to give signs of self-sustainability. We have been arguing for some time that income generation is the ultimate driver of private consumption, and that is faltering now. While we don’t expect much contribution to growth coming from most aggregate demand components (public spending will be neutral at best and most likely a drag, a strong dollar will keep the contribution of net export to growth flat; investments will be weak as capacity utilization remains low and housing loses steam on the expiration of the tax credit) we are again at the mercy of the U.S. consumer. The U.S. consumer will have to continue to deal with sluggish income generation, tight credit markets, losses of wealth coming from housing and lately from equities as well. As we argued in our Q2 2010 U.S. Outlook, income generation from Census hiring is likely to be very limited (less than 0.1% of annual income). Therefore, signs of strong hiring in the private sector and income growth are what we would like and need to see. Even if the surge in private employment for two months in a row (in March and April) is a clear sign of recovery, we remain skeptical about the full self-sustaining nature of it, and this latest job market report only confirms our concerns. We still believe that the second half of the year will display weaker growth as personal consumption growth aligns with income growth, inventory growth aligns with final sales (still a weak spot) and fiscal stimulus turns neutral or becomes a drag on growth. In normal times, the labor market needs to create around 130,000-150,000 jobs per month to absorb increases in the work force. Clearly, given the slack in the market, job creation must go substantially beyond that range to reduce the unemployment rate during this recovery. This is consistent with our forecast of unemployment peaking at 10.1% in Q1 2011.

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