Bad for the Jobless, Good for Rates


By Michael Englund The U.S. economic recovery continues to press forward, and yet something is missing: robust job growth. The April employment report released on May 3 revealed a surprisingly sluggish gain in new jobs -- 43,000 were added for the month -- and a decline in the average number of hours worked per week, despite ongoing evidence that production and sales remain strong.

The key culprit appears to be the continued strong growth in productivity. Robust productivity increases will likely continue in the second quarter, after strong gains in the previous two quarters. A sustained surge in productivity will provide the Federal Open Market Committee, the rate-setting arm of the Federal Reserve, with even greater leeway in timing its next policy reversal. Muted wage increases and a high and rising unemployment rate mitigate fears that the Fed is waiting too long to take back the interest rate cuts of 2001. We at Standard & Poor's MMS are projecting now that the Fed can wait until September to raise interest rates.

The 43,000 jobs gained in April were actually quite close to expectations, but the rise followed a sizable downward revision of 81,000 in the level of payroll employment in March. That reversed what was originally reported as a slight gain for March, to a decline of 21,000. This weakness, which was led by a small downward revision in March construction employment and an ensuing April decline of 79,000, was also accompanied by an unexpected drop in the workweek to 34.1 hours from 34.2.

SHALLOW UPTREND. The numbers through April leave the data on track for total hours-worked to show no gain during the second quarter, following a 0.5% contraction in the first quarter and a 3.8% peak decline in the fourth quarter of 2001. Though the trajectory is upward for the payroll figures, the workweek figures, and the hours-worked figures overall, the uptrend is notably shallow relative to the enormous strength in most measures for sales and output.

The figures for factories weren't nearly as weak. The workweek in this segment remained steady, overtime rose by 0.1 hours, and temporary jobs continued strong, implying that the factory sector is still gearing up. But even these trends are failing to keep pace with the sizable gains evident in output. Because of strength in automotive output, industrial production should post a 0.5% gain in April and is poised to grow at a robust 5.7% clip in the second quarter, following a 2.5% growth rate in the first quarter and a 6.9% decline in 2001's fourth quarter. Not bad for a sector that shed 19,000 jobs in April.

This combination of figures for the factory sector is characteristic of what's happening to the economy overall: An enormous and seemingly sustained productivity boom is allowing a third straight quarter of output growth to exceed any growth in hours worked by 5% to 7%. That's practically unprecedented.

MONETARY POLICY BONUS. When the hefty 5.2% productivity increase was reported for 2001's fourth quarter, it appeared to be some sort of quirky measurement flaw that may have been somehow related to distortions to economic data following the September 11 attacks. But productivity growth in the first quarter -- likely to reach 6.5% to 7% -- extended this pattern for another quarter. And the April data imply that the trend has not yet stopped.

The benefit of a robust productivity trend for monetary policy is, of course, the effect it has on the labor market. This was clearly evident in the April employment report, as the sluggish payroll figures corresponded with a long-awaited surge in the unemployment rate to 6% and a remarkably weak 0.1% gain in average hourly earnings. Year-over-year growth for this measure plummeted to 3.2% (on a nonseasonally adjusted basis) in April from 3.5% in March, 3.7% in February, 4.0% in January, and a business cycle peak of 4.5% in September.

What the employment report is telling us, then, is that the economy is continuing to grow at a healthy pace, but that strength is translating to even less of a wage-inflation threat than we had assumed. And that keeps the pressure off the Fed to pull the trigger on an interest rate hike. Englund is chief market economist for Standard & Poor's


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