Economic Perspective on July 2018 Jobs Report

By John Beuerlein, chief economist, Pohlad Companies

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Most recent economic reports continue to paint the picture of a strengthening economy. While history is important, the bigger question is whether or not this momentum is likely to continue into the second half of 2018. The Bureau of Economic Analysis (BEA) reported on July 27 that 2Q-18 real GDP grew at the fastest rate since 3Q-14. The 4.1 percent annualized pace of real growth in second quarter was up from the revised growth rate of 2.2 percent in the first quarter of 2018. More recently, on August 3, the Labor Department stated that nonfarm payrolls increased 157,000 in July, moderately below consensus. Coupled with upward revisions to the May and June reports of 59,000, the total employment gain for the July report was 216,000. Unemployment improved from 4.0 percent to 3.9 percent. In short, employment numbers remain strong. Continuing to provide some consternation among analysts, however, is the fact that average hourly wages have yet to accelerate to the upside. The payroll report stated that average hourly wages were growing at 2.7 percent year-over-year. Wage gains have been growing between 2.6 percent and 2.8 percent year-over-year for the past eight months. With the recent reading of the Consumer Price Index at 2.8 percent, average hourly wages are not keeping up with this measure of inflation. Wages are improving, but the rate of growth remains tepid. Wage pressures are still sufficiently moderate to prevent Fed officials from worrying that they are at risk of falling behind the inflation curve. Some caution for those looking ahead comes from the July report of the Institute of Supply Management (ISM), which indicated some moderation of economic growth at the beginning of the second half of the year. New orders have dropped to the lowest level of the year, suggesting some softening in demand. Meanwhile, the Fed appears to be on track for another increase in the Fed Funds rate at their September meeting, bringing the rate to 2.25 percent. The bigger question is whether or not they will raise rates another 0.25 percent at their December meeting. The markets are sensing the possibility of the economic slowing mentioned above as a result of the developing trade tensions coupled with the continued strength of the U.S. dollar and are consequently assigning only a 65 percent chance that they will raise rates at their December meeting. The yield curve, as measured by the difference in yields between the 10-year Treasury Bond and 2-Year Treasury Note, remains tight at approximately 30 basis points. This phenomenon is garnering a lot of attention because of its historical track record of accurately indicating that a recession is likely to occur in 12-15 months once the curve inverts. While this relationship warrants continued observation, the point is that even if the curve does invert, there has typically been about a year before the economy begins to slow significantly. In summary, although the economy is unlikely to maintain the momentum demonstrated in the second quarter, the major signs that have historically indicated the beginning of the next recession are not yet in place. Unemployment is low; wages are rising only gradually; the Federal Reserve is tightening, but real interest rates are near zero; inflation remains subdued; the yield curve is not inverted; profits are increasing; and the leading indicators are still rising. Until some of these indicators change, the chances of a recession developing are minimal.