The Jobs Explosion


By Michael Englund From the looks of the July employment report, released Aug. 5, U.S. job growth has finally caught up with the strength evident in nearly all the other economic data over the past two months.

Not only did the headline nonfarm payrolls figure increase by 207,000 -- well above economists' median forecast of 180,000 and just a touch above Action Economics' own estimate of 200,000 -- but data for both May and June were revised higher.

Surprisingly, too, the strength extended to one component of the report that caused financial markets some discomfort: Wage growth. Average hourly earnings rose 0.4%, above market expectations, and at a pace that will cause some inflation jitters.

UPSIDE REVISIONS. The strength in the payroll data adds to the solid economic momentum we expect in the third and fourth quarters, and it's no doubt being scrutinized by Federal Reserve policymakers.

We expect the Fed to continue hiking rates through 2005 and into early 2006. We project a 4.5% Fed funds target by the end of the February Federal Open Market Committee meeting, with risk that the jump in average hourly earnings could prompt Alan Greenspan & Co. to quicken the pace of tightening. Still, a quarter-point hike is universally expected at the upcoming Aug. 9 FOMC meeting.

The July report was unambiguously strong. The market always obsesses on the reported job count each month, and these latest figures reveal a solid gain alongside what has now become the typical upward revisions for prior months, leaving a "revision-adjusted" 249,000 gain when the May and June tweaks are taken into account.

This marks roughly a 49,000 upside surprise, and leaves a pattern of mounting strength. Of course, we should assume the July figure will be revised upward as well, and the lean level of weekly initial claims as we enter August suggests risk of another strong report next month.

CLEAR STRENGTHENING. Looking at the other key components of the report, the unemployment rate held at 5% (median 5%). The hours-worked index posted a respectable 0.2% gain in July.

Despite some weakness in the factory data, we expect an industrial production gain of 0.5% in July that will follow a 0.9% surge in June, demonstrating a clear strengthening trend.

A lackluster figure for April left a notably restrained 2.1% growth rate for industrial production in the second quarter, but we now expect a 5.7% growth clip for this measure in the third quarter as second-quarter weakness is reversed.

THE MICROSOFT EFFECT. The personal income data are also revealing a solid rebound, thanks to the hefty 0.4% hourly earnings gain in July, alongside strong payrolls. The data imply that this should support a 0.5% income gain, along with the 1.3% surge now likely in personal consumption expenditures.

We are seeing a clear acceleration in these measures. However, the gains pale in comparison to the distortions in the December and January data stemming from the hefty Microsoft (MSFT) dividend, making uptrend in these figures over the past year more difficult to discern in the monthly or quarterly data.

Growth in the hours-worked index is likely to slow in the third quarter, to 1.6% from the 2.8% growth rate reported for the second. But the second-quarter gain marked the strongest quarterly hours-worked increase since the fourth quarter of 1999, leaving an upside impetus to the quarterly Gross Domestic Product figures for 2005 even despite the modest correction in the figures in the third quarter.

LOOK TO DEMOGRAPHICS. What does this all mean for overall U.S. economic growth? Well, GDP is clearly accelerating through the second and third quarters, though it is unclear how the final June business inventory data will show how this strength was divvied up between the two periods. As it stands, if the 3.4% second-quarter GDP gain holds, we expect a 5.2% GDP gain in the third, with productivity posting a solid 3.8% growth clip after a restrained 2.0% gain projected for the second quarter.

Though there was much talk last year that job growth was underperforming in the current economic upcycle, vs. past cycles, this is best seen as a reflection of a broad demographic slowdown in labor-force growth rather than some shortfall in job creation. The U.S. unemployment rate continues to trend downward in this cycle at a typical rate, and at virtually the same rate as seen during the 1990s expansion.

Wage growth in the last expansion began to trend upward as the unemployment rate dropped into, and eventually below, the 5% to 6% range, and this is repeating itself in this cycle. We expect a 4.9% unemployment rate in August, and 4.8% rate by yearend, with a gradual upward trend in wage growth.

GREENSPAN'S LAST HOORAH. We don't think net job creation in the U.S. could grow at much of a faster rate than the 183,000 average monthly gain posted in 2004, and the 191,000 average now evident through the first seven months of 2005.

The solid employment trends, coupled with the current inventory build, mean that "soft patch" risks have now been replaced with the likelihood of upside surprises in terms of growth. While July's wage-growth numbers, and still-elevated energy prices, indicate that inflation risks will be a continuing concern, the U.S. economy appears to be on a steady track as Chairman Greenspan enters the home stretch of his tenure as head of the central bank. Englund is chief economist for Action Economics


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