Emma Wall: Hello, and welcome to the Morningstar series, "Market Reaction." I'm Emma Wall and I'm joined today by Rathbone's Ed Smith to talk about US employment figures.
Hi, Ed.
Edward Smith: Hello, Emma.
Wall: So, we've had some employment figures out from the US on Friday. But before we go into the details of those particular ones, I thought you could explain why US jobs figures are a data point that economists across the world pay attention to.
Smith: Well, first of all, it's an incredibly rich data release. We have tens of thousands of lines of data released in that jobs report. And of course, the US is still very much the barometer of the western world economy, accounts for the lion's share of the G7 GDP data and is, of course, almost 50% of the MSCI World Equity Index. So, investors are interested are, too.
Now, the level of unemployment in the US is a really important indicator for where we are in the business cycle. And of course, equities behave very differently at different stages of the business cycle. And I'm an asset allocator. So, my first point of interest is whether I should be in equities or bonds. Now, the performance of equities relative to bonds is the mirror image of something we call the unemployment gap. So, what the level of unemployment is relative to trend unemployment, a slow-moving average. If unemployment is accelerating away from the trend or it's getting lower and lower further below the trend, we say that the unemployment gap is rising. And that means that equity markets are going to outperform bonds. And if you see that relationship on a chart, it really is an incredible mirror image. So, it's really important.
But the data we get with the jobs release is full of coincident indicators, which tell us what the economy is doing right now and of course, to get a jump on equity markets, which tend to be forward-looking, you need to look at some of the leading economic indicators and they are not necessarily in that report.
Wall: Having said all that, the most recent jobs figures that came out on Friday, what trends can you see in that set of data?
Smith: Well, it was a really strong release. We had an extra 313,000 jobs. Only 205,000 jobs were expected to be added in February. Previous two months’ job creation was also revised up by about 54,000. So, that's great news. It means the health of the labour market is continuing to improve. That unemployment rate doesn't look as thought it's going to start to tick up, start to close that gap when bonds might start to outperform equities.
So it was really encouraging. There was a broad base of jobs creation against different sectors. But there were some interesting points as well. Manufacturing added a lot of jobs and construction did as well. And those two things are very close to Trump's heart. And actually, his policies could mean that manufacturing companies and construction companies may be in for a bit of cost pressure because they are adding all these jobs. But if he starts to curtail immigration a lot more, that means far fewer people for construction companies to employ, particularly as some of them are known illegal immigrants. And manufacturing jobs are also increasing because of global trade, but of course Trump wants to limit the US's involvement in global trade and that might have some effects there, too. So, there's lots of interesting stuff to think about.
Wall: Now, the previous jobs figures caused a bit of a global stock market upset because they were much better than expected in terms of wage inflation, which caused inflation concerns, which led people to say that the Fed would hike rates more than three, four times this year and so markets got spooked. In regards to the most recent figures out just on Friday, what can we conclude the Fed might do based on that more recent data?
Smith: Well, I think, there were sighs of reliefs echoing across trading floors all around the world on Friday afternoon because the headline rate of wage inflation fell back to 2.6%. It was originally estimated at 2.9%, that's the annual rate of change, and that's when the markets got spooked. We have that big correction. That was revised down actually a little to just 2.8% and the next set of numbers was just 2.6%. So, big sigh of relief and that perhaps might mean that the Fed doesn't have quite so much impetus to increase rates by more than three or four times this year, which of course, is what markets were worried about.
First of all, we do question that the theory that a strong wage growth necessarily means the Fed is going to hike. Wage growth even at 2.9%, that's still reasonably low by historical standards.
We don't buy into this idea of that there's this big hockey stick moment in the Phillips curve. That relationship between unemployment and wages. When unemployment gets so low, suddenly wage growth goes right through roof. We don't see that when we do the historical analysis.
And thirdly, there's very little correlation between wages and inflation these days anyway. And the Fed is interested in price inflation, not necessarily wage inflation. And if there not much correlation, then perhaps we overstate the importance of the wage numbers in the payrolls report.
Wall: Ed, thank you very much.
Smith: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
