In our business a Goldilocks scenario refers to a macro-economic environment where economic growth is strong enough to support earnings growth, but not so strong as to generate inflation and provoke a central bank into tightening monetary policy (i.e. raising interest rates).
The US labour market report for January 2017, released on 03/02/17 would fit into a Goldilocks macro-economic screenplay. The US Bureau of Labor Statistics (BLS) announced that 227 000 jobs were created in January, much higher than expected and the strongest monthly gain since September 2016.
Annual growth in employment was steady at 1.6% year-on-year (YoY) after having slowed for three straight months (see Exhibit 1 below).
An increase in the labour force participation rate pushed the unemployment rate higher to 4.8%. A broader BLS definition of ‘labour underutilisation’ (i.e. unemployment) moved up 0.2%-point to 9.4% in January. This suggests that there is more slack in the US labour market than suggested by the official unemployment rate. Indeed, hourly wage growth cooled in January, triggering a fall in the annual rate of wage growth.
Exhibit 1: Changes in the annual rate of growth in US employment, hourly nominal and real wages between 2000 and January 2017
That brings us back to Goldilocks: economic growth without inflation. Last week the press statement following the Federal Reserve’s (the Fed) monetary policy meeting was a bit more positive on growth, but did not do much to change the signal of a possible three rate hikes from the Fed in 2017.
Having said this, the markets’ expectations for Fed rate hikes in 2017 have fallen marginally and equity markets reacted favourably to the employment data. The ISM and Markit surveys of sentiment among companies continue to signal an improvement in GDP growth in coming months. The Atlanta Fed, which tracks GDP growth based on the most recent data, has raised its forecast for QoQ annualised GDP growth in Q1 to 3.4% (from 2.3% a week ago). Our own nowcasting index points to 3.0%.
One month of stronger employment growth does not change the trend of moderation
Our base case for the US economy is a macro-economic context that may be close to a Goldilocks environment with the proviso that the level of economic growth may be slightly too weak to be really positive.
Looking at the US labour market, one month of stronger employment growth does not change the bigger picture trend of moderation. According to a survey among households, employment growth slowed to 1.0% YoY in January. The Fed’s Labour Market Conditions Index, which tracks a broad range of labour market indicators, slipped back into negative territory in December.
The level of growth in real disposable income sets a limit on the rate of consumption growth, unless…
Moreover, while the inflation rate may be modest by historical standards, with modest nominal wage gains, it has been high enough to significantly constrain real wages. We have stressed before that the level of growth in real disposable income sets a tight speed limit for consumption growth, unless consumers compensate on the shortfall by dipping into their savings or leveraging up. Their propensity to do so may well have changed in the wake of the Great Financial Crisis.