January 6, 2017— Job growth came in at 156,000 for December, which was in line with our expectations of 155,000 but below the consensus median estimate of 175,000. For all of 2016, the U.S. added 2.2 million new jobs or about 180,000 per month. That is well below the 2.7 million added in 2015 when the monthly average was about 230,000 and even farther below the 2014 which was the strongest year for job growth of this recovery. We believe the slowdown in job growth is due to a tight labor market, reflected by the unemployment rate, in an environment where companies are still looking to hire. Separate company surveys are showing an increasing share of companies and industries reporting they cannot fill open positions due to lack of qualified workers. The construction sector in particular, a major detractor in this report, is struggling to find people.

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Source: Bureau of Labor Statistics

The unemployment rate moved up slightly to 4.7% in December from 4.6% the month before, but still remains quite low and probably at or below the long-term equilibrium rate, which we think of as about 5%. In such a tight labor market, companies are finding it challenging to fill positions, which drags out the hiring process and also puts upward pressure on wages.

Wage growth continued its upward momentum coming in at 2.9% year-over-year in December, the best pace since 2009 and a nice bump from the 2.5% posted the previous month. The low reading in November looked to us to be hindered by statistical noise and did not fit with the overall labor market tightness and media stories of wage increases for countless large companies. With the unemployment rate low, the labor market is tight enough to continue driving wages higher in 2017.

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Source: Bureau of Labor Statistics

Direction of labor force is the key

The degree of tightness of the labor market is a hot point of debate and has important ramifications for job growth, wage pressure, inflation, and by extension the path of interest rate normalization pursued by the Fed. While the Bloomberg consensus forecast of job growth each month grudgingly moved down below the 200k mark in the second half of 2016, many members of Federal Reserve’s Federal Open Market Committee (FOMC) that makes decisions on interest rates have much lower expectations. The FOMC members often speak in terms of the number of jobs needed each month to keep the unemployment rate steady, which is dependent on labor force growth. Many members have spoken of figures in the 100,000-150,000 per month range, while others have put that figure as low as 85,000.

The chart below shows the one-year growth in the labor force, which is volatile and highly sensitive to recessions (gray bars). The ten-year growth shows the underlying deceleration in labor force that is significantly affected by population growth. It peaked  at 2.4 million and has mostly been decelerating since to about 800,000 in 2016. The three-decade slowdown is being caused by slowing population growth and more recently by the well-documented aging of the Baby Boomer generation. Labor force growth was very strong in 2016, but if it reverts to the to the longer term slowdown, then the labor market will tighten even more and wage pressure will increase. There is very little consensus on this topic among the FOMC or economists generally. We are encouraged by the increased labor force participation in 2016, but are doubtful that growth can remain at 2 million per year in the face of the retirement of Baby Boomers. We expect labor force growth to slow in order for labor markets to remain tight and keep that upward pressure on wages. 

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Source: Bureau of Labor Statics

Core narrative

U.S. employers maintained a modest pace of hiring in December while raising wages, putting the economy on a path to stronger growth. We believe that the U.S. has a sturdy labor market that is still expanding, but has slowed because of tightness. That tightness naturally leads to higher wage growth. This assessment of labor market tightness keeps the Fed on track for further rate hikes in 2017, and supports our current positioning of a slight overweight to U.S. equities.

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