The Federal Reserve has a problem to deal with that it's not been addressing publicly and that's causing problems for it and the markets.
The May employment report released yesterday by the Bureau of Labor Statistics provides further evidence of a bifurcating economy, which is a subject I last addressed after the April employment report was released in the column, "Employment Report: A Tale of Two Economies Creating a Fed Headache."
The crux of the matter facing the Fed and the markets is the evidence of a widening mismatch between the skill sets human labor can provide to employers and the skill sets employers are demanding.
This is leaving the U.S. with two economies.
One economy is made up of the members of the labor pool who have skills sets that are in demand. The availability of those people is decreasing and nascent signs of wage pressure are growing as a result.
Tom Graff offered an excellent synopsis of this in his column, "4 Takeaways From a Shocking Jobs Report," so I won't reiterate the same here.
The other economy is made up of the growing percentage of people without in-demand skill sets and they are increasingly being migrated into the not-in-labor-force number as there are simply no jobs for them.
The combination of these two events is reflected in the unemployment rate dropping to 4.7%.
That puts the unemployment rate at the lower bound of the Fed's estimate of an indication of full employment, called the "natural rate of unemployment" (NROU). I explained its importance in the column, "A Primer on Fedspeak."
The Fed announces the NROU every other meeting in the summary of economic projections and provided it last in conjunction with the statement release following the March 15 FOMC meeting.
The Fed has been consistently reducing the NROU as the unemployment rate declines, but evidence of wage and inflationary pressures has been absent.
The Fed will have to address the subject again with the statement release on June 15.
The issue now, however, is that the rate of increase in wages is greater than nominal GDP or inflation, measured by either consumer price index or personal consumption expenditures.
That is an indication that the people who are employed are finally beginning to show real income gains, while the people who are unemployed, whether or not they are counted in the labor force, do not have the financial means to drive consumption that is commensurate with wage gains.
Traditionally, the Fed's primary consideration in setting monetary policy is with those who are employed or eligible for and seeking employment.
As the official unemployment rate approaches the NROU, it is supposed to indicate that wage pressures are imminent and those pressures imply that an increase in consumption and inflation will follow, warranting an increase in the Fed Funds rate target.
The Fed's been afforded the opportunity to ignore the intersection of the unemployment rate and NROU because wage pressure hasn't been evidenced until the past few employment reports, and adjusted for it by lowering the NROU and punting on rate hikes.
Now the Fed has the unemployment rate at the NROU and wage pressures building, but without the increase in consumption and inflation that has traditionally begun to be evidenced by such.
The Fed has not addressed what it would do if this situation arose.
We don't know if it will focus on wage gains and the unemployment rate, which suggest raising rates, or on consumption, which suggests that not only should it not do so, but that stimulus is necessary.
This is not a new issue either.
It's been apparent that such a situation may arise for many months. I addressed the increasing capital market volatility that would logically result and the Fed not directly addressing it and how the Fed would consider it for monetary policy purposes in the column, "We're Getting Signs of More Volatility Ahead."
With the next FOMC meeting two weeks away, any communications from FOMC members until then need to be monitored closely, as transparency of the logic used by the FOMC in their decision making is increasingly opaque.
Even if the Fed punts on rates in June and lowers the NROU again, the market participants are going to start becoming increasingly vocal about the desire for answers as to how the Fed is going to address the situation in the near future if the bifurcating trajectory continues.