What the 'Messy' August Jobs Report Means for Investors and the Fed

The August employment report was kind of a mess. The headline job growth number was a massive miss, coming in at +235,000 vs. expectations of +725,000. Yet wage growth lurched higher, the unemployment rate fell, and perhaps more confounding, bond yields jumped higher. So what the heck is going on here? Delta Variant Infects Payrolls The combination of Accommodation, Leisure/Entertainment and Food Services sectors combined to add zero jobs in August. That group added 377,000 jobs on average over the prior three months. Right there is the majority of the miss. Actually, if we add back in the prior revisions, that accounts for all of the miss. It seems pretty clear that is an effect from the Delta variant's spread. Unfortunately, I'd guess the effect from Delta could be even worse next month. The payroll survey was conducted the week of August 9. In order to count for the survey, you have to be on the payroll that week, which means the decision to hire any new people would have come a couple weeks prior to that. With Delta infections ramping up all month, it seems logical that even more firms would have paused hiring (or cut headcount) since August 9. Worth noting for these sectors specifically, if an hourly employee doesn't get any hours in a given week, they don't count as employed for the payroll survey. I'm inclined to think the intermediate-term effects of Delta will be more felt in supply chains than consumer spending. However, for the moment, perhaps this payroll result should be a reminder that just because there aren't a lot of new legal restrictions doesn't mean consumers won't change behavior. Tapering Now in Doubt? I don't think this will change anything about the Federal Reserve's plans for QE tapering. Chair Jerome Powell spent all that effort at Jackson Hole separating the tapering decision from main monetary policy decisions. Why back down just because of one jobs report? But more importantly, the Fed wants out of the QE business. It is causing all kinds of distortions in the short-term rates markets, and they are tired of cleaning up the mess. Labor Supply Remains Weak The Unemployment Rate ticked down 0.2 percentage points. This was partially because Household Survey employment growth came in at +509,000, a good bit better than the Establishment Survey. But it was also because labor force growth continues to be middling. In August, 190,000 people joined the labor force, which essentially is only enough to keep up with population growth. We just aren't adding new workers fast enough to keep up with demand. Readers of my columns have heard me emphasize labor supply over and over again, so I won't belabor it. Suffice to say that the anemic labor supply growth suggests that the current labor market tightness isn't going to abate anytime soon. Speaking of which... Wage Growth Pops Average Hourly Earnings jumped 0.6% in August, double the expectation from Bloomberg's survey. There could be some effect of mix in there. With weak job growth from some lower paying sectors, such as the hospitality sectors mentioned above, that can overstate wage growth. Regardless, the bigger picture is clear here. The labor market is very tight in general. Hence it is expensive for employers to hire anyone. In addition, employers are increasingly under threat to lose their people to higher bidders. That increases wage pressure all the more. Admittedly, rapid wage growth may be necessary but not sufficient to cause inflation. However more wage pressure definitely increases the potential for higher inflation. Also, importantly, persistent wage growth is more likely to foster longer-lasting inflationary pressure. The more persistent inflation pressure is, the more times the Fed will ultimately hike. This is the most likely reason why the bond market is selling off in response to the payroll report. Another reason might be a little counter-intuitive. Part of why bonds are selling off Friday is because people think this number puts the Fed on hold for longer. Remember that part of the bond bull narrative was that any Fed hikes would be a mistake, impairing growth and hence causing long-term yields to decline. Therefore something that pushes rate hikes back is actually bond negative, according to this view. Supply vs. Demand Over the last 40 years, variation in U.S. economic data has been entirely about fluctuation in demand. Weak sales were because people didn't want to buy. Weak production was because firms didn't think they could sell the product. Weak employment growth was because firms didn't want to hire. You get the picture. So on a day like Friday, where payroll gains were a huge miss, we would assume firms were worried about future sales and therefore were slowing hiring. Today any weakness in economic data has been supply-related. Firms want to hire, they want to produce, etc. But there aren't enough workers or enough inputs. When demand is the problem, there are straight-forward policy solutions. The Fed can lower the cost of capital, the government can ramp up spending and/or cut taxes, etc. Supply constraints aren't easy to fix. An economy's productive capacity is more or less fixed in the short-term. It takes a long time to build a new factory. It takes a long time to grow more people to become workers. Once a company cannot produce more, if demand continues to be high, there's only one logical conclusion: raise prices. If you can produce 100 of your product, and consumers want to buy 100 of your product at price x, then x is going to be the price. But if consumers want to buy 110 at price x, then it is only sensible that you raise price until demand is only 100. This is microeconomics 101 stuff. What we have now is a whole economy in this same position. Fortunately some of the supply constraints may abate as the pandemic subsides. However, I expect one core problem to remain: labor. Without more people to make more stuff, the economy's ability to produce will be hampered. I believe this will translate into lasting inflation pressure, which will necessitate a response from the Fed eventually. The question becomes whether demand remains hot even while supply is weak. There are those that think the U.S. will ultimately turn into Europe, with low and unresponsive inflation, and effectively assuming that demand falls off such that tight supply stops being a problem. I suppose that's possible, but I think it is more likely that strong wages fuel strong aggregate demand and this creates an inflationary feedback loop. If at some point we start seeing weak demand for labor, then I'll change my tune. For now I'm inclined to think inflation will remain elevated for the foreseeable future.

What the 'Messy' August Jobs Report Means for Investors and the Fed

This payroll result should be a reminder that just because there aren't a lot of new legal restrictions doesn't mean consumers won't change behavior.

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