While the latest U.S. jobs numbers are not setting records, that’s not the right threshold for assessing the inflation threat. The employment market looks very strong and will likely continue to concern the Fed.

In Focus - Job Market Strength

Last week’s U.S. June jobs data drew a range of reactions. The key numbers – 3.6% unemployment and especially 209K new jobs – were greeted in one account as short of expectations, demonstrating jobs growth “wobbles.” Alternatively, there was former Treasury Secretary Larry Summers describing the job market as “hot” and predicting further Fed rate hikes. So, which is it?

In fact, job market data were remarkably consistent across a range of measures. While the numbers are no longer record-setting, they are historically strong. We could compare them to historical extremes (they fall short), or to expectations (depends on who is expecting), but the central macroeconomic question is whether they reflect a sufficiently tight job market to cause inflation worries (yes).

This week’s chart looks at the last couple of decade’s worth of data for two particular measures. The unemployment rate (dark) hit a recent low of 3.4% in January and April. But if one looks at monthly rates back to December 2000, the latest figure is among the lowest 4%. An alternate measure, only available through May, shows the ratio of unemployed workers per job opening. This hit a recent low of 0.50 in March 2022, but the May 2023 reading of 0.63 was among the lowest 7% of monthly readings.

There are other popular measures of labor market strength. One can look at the rate at which people quit their jobs, which tends to reflect confidence in the ability to land a new position. This was 2.6% in May 2023, short of the recent peak of 3.0% in April 2022, but still in the top 9% of monthly numbers over the last couple decades.

The employment-population ratio for workers ages 25-54 was 80.9 in June, the highest it had been since April 2001. This figure is worth keeping in mind when considering whether the 209K job growth number was high or low. As we’ve said before – at some point, job growth is limited by the number of people left to employ.

Why can’t we just be happy that lots of people have jobs? The concern is that excessively tight labor markets prompt employers to raise wages to attract workers and, thus, lead to inflation. In June, average hourly earnings were up at a 4.4% annual rate, the same as for the previous two months.

Further, if we do some quick and dirty calculations, in monthly data since March 2007, there has been a -25.4% correlation between the unemployment rate and average hourly earnings growth. The number is -39.0% between earnings and the unemployed/job openings series. Roughly, the lower the series on the chart go, the higher wages go.

Of course, that doesn’t prove causality. Nor does it address issues of timing. Should a tight labor market in June have an immediate effect on wages? Or does it take a few months of business frustration with hiring to prompt higher wage offers?

But the correlations loosely illustrate why the latest job numbers will be of concern to the Fed and are likely to provide support for further rate hikes. The Fed wants to bring inflation down to 2%. That looks difficult with a labor market as tight as it is.

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This week we will cover Italian Manufacturing Exports to the United States.

Economic Developments

The U.S. 12-month trimmed-mean PCE inflation rate was 4.6% in May, a drop of 0.2% percentage points from April. The core 12-month PCE deflator, which strips out volatile food and energy prices, was also down, falling 0.1 percentage point to 4.6%. Both trimmed-mean and core PCE inflation numbers are trying to extract underlying inflation trends from a noisier set of numbers. They are particularly important in Fed decision-making.

U.S. real personal consumption expenditure was essentially flat in May, falling by less than 0.1% from April. It was up 2.1% from May 2022, however. Spending on goods was down 0.4% from a month earlier, with outlays on durables 1.4% smaller, offsetting a minor rise in spending on non-durables. Spending on services was up 0.2%.

The U.S. Manufacturing PMI for June contracted for the eighth straight month, dropping to 46, the lowest result since May 2020. Any reading under 50 indicates a contraction; none of the ten sub-indices were above 50 and the employment component declined 3.3 percentage points to 48.1, with layoffs, rather than hiring freezes or attrition, playing a larger role in labor force management than they had been.

Euro area retail sales were unchanged in May from the previous month but were down 2.9% from May 2022. German retail sales, however, registered a month-on-month increase for the second consecutive month, rising by 0.4%. They also rose in Spain and the Netherlands, but fell by 0.7% in France.

Last week’s major trade data releases showed both signs of weakness and strength moving into the summer months, with automotive trade continuing to be a bright spot.

• U.S. real goods imports decreased 2.3%, or $5.3 billion, month-on-month in May, while real exports increased 1.2%, or $1.7 billion. Year-to-date, imports are down across all major categories compared to the same period last year, with the exception of automotives and vehicle parts, which were up 10.6%. At 13.2% consumer goods imports saw the largest drop. Autos and vehicle parts exports were also the strongest category of exports, up 10.5% through May.

• Germany’s exports were down 0.1% month-on-month in May and 0.8% year-on-year. The overall figures were dragged down by exports to the EU, while exports to extra-EU countries increased by 1.8%, helped mainly by rises in shipments to China (+1.6%) and the UK (+5.8%). Exports to the U.S. fell by 3.6% from April. The totals are adjusted for seasonality and calendar differences but not prices.

• Mexico light vehicle exports jumped 20.7% year-on-year in June, the 15th consecutive month exports increased by this measure. The total number of vehicles exported was 286,291, the highest volume since November 2020. Year-to-date, exports to the U.S., by far Mexico’s largest market, are up 10.2%.

Political Developments

U.S. Treasury Secretary Yellen was in Beijing last week to discuss the economic relationship between the U.S. and China. In remarks following two days of meetings Secretary Yellen emphasized a distinction between decoupling and diversifying supply chains, as well as interests of national security. She also said she pressed her Chinese counterparts on “unfair economic practices,” including non-market policies, IP protection and market access for U.S. firms. There was also discussion of areas where the world’s two largest economies can cooperate, such as on climate change and the sustainability of sovereign debt.

Ahead of Secretary Yellen’s visit China announced export restrictions on two rare earth minerals – gallium and germanium – used in the production of semiconductors and electric vehicles and telecoms equipment. The restrictions are scheduled to begin on August 1st. The move is largely viewed as China’s response to U.S.-led measures to prohibit firms from exporting advanced semiconductors, and equipment used in the production thereof, to China. China is estimated to account for 98% of refined gallium and nearly 70% of refined germanium.

On June 30th, the Netherlands announced that from September 1st, Dutch firms – but almost entirely a single firm, ASML – will have to apply for licenses to export equipment for production of advanced semiconductors to China. This follows similar moves by the U.S. and Japan earlier in the year.

The U.S. submitted a “paper” for reforming and reviving the WTO’s dispute settlement system, which hasn’t functioned since the Trump administration blocked appointments to the appellate body, a policy the Biden administration has left unchanged. The U.S. stressed that the document was not a formal proposal, nor should a formal proposal be expected in the near future. Among the ten “positive examples of a reformed dispute settlement system,” the paper noted that it “cannot be a forum for debating and deciding on the essential security interests of Members.”

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