Morgan Stanley: "Wage Growth Is Leveling Off, May Be Slowing"

While Friday's headline payrolls print - the lowest since May - was disappointing even to the biggest economic optimists, many found refuge in the sharp drop in the unemployment rate, which ticked lower to 4.5%, the lowest print in a decade. And yet there was a problem: with the unemployment rate tumbling, at least in theory indicating even less slack in the labor market, wage growth barely hit consensus estimates. Instead, if indeed the growth narrative is accurate, and if more people were employed, wages should be rising. However, it was this weakest link of the entire reflation/recovery narrative that disappointed once again.

In fact, it was even worse: as Morgan Stanley's Robert Rosener write overnight, "wage pressures in March were supported almost entirely by a massive jump in earnings in Professional & Business Services. Outside of this bright spot, wages in other industries were muted, and suggests wage growth in a broad range of industries may be leveling off, or even slowing."

As Rossener further notes, to describe wage pressures in March as 'spotty' may be an understatement. The 0.19%M gain in average hourly earnings was supported almost entirely by a massive jump in the Professional & Business Services industry. Outside of this one bright spot, wage pressures in other industries were surprisingly muted (Exhibit 1), and suggests wage growth in a broad range of industries may be leveling off or even slowing.

According to MS, the 0.92% sequential gain in average hourly earnings in Professional & Business Services was the second largest monthly increase on record, and this accounted for nearly all of the increase in aggregate average hourly earnings. In other words, average hourly earnings would have been roughly flat on the month were it not for the outsized increase in earnings for Professional & Business Services. To be sure, the bounce in wage growth for this job category was decidedly welcome: As a generally high-paying industry, stronger wage growth in Professional & Business Services can go a long way in supporting stronger aggregate outcomes for average hourly earnings.

The key question from here is whether or not the upside in March can be sustained, or if it's just noise.

Yet while the silver lining in professional services will be closely watched, a bigger question is what happens to wages in all the other key indudtries, where as noted above, March saw substantial weakness.

Here, Rosener writes that "consistent with signs of a recent softening in wage pressures in a number of industries, our wage growth diffusion index has shown a meaningful narrowing in the breadth of wage pressures across industries in recent months—only 38.5% of industries are now showing above-trend rates of wage growth, down from 46.2% in February and a high of 61.5% in August 2016."

Some more observations from Morgan Stanley:

  • The jump in average hourly earnings in Professional & Business Services helped boost wage growth in the broader high-wage industry segment as a result, with average hourly earnings in high-wage industries rising to 3.0%Y in March from 2.7%Y in February (Exhibit 5).
  • Wage growth in middle-wage industries fell sharply in March to 2.1%Y vs 2.6%Y in February (Exhibit 6).
  • Wage growth in low-wage industries ticked down to 2.6%Y from 2.8%Y, although smoothing through the volatility shows a steady trend for wage growth in low-wage industries around 2.6%Y (Exhibit 7).
  • Consistent with fewer workers experiencing wage gains, the median rate of wage growth across industries fell notably in March. Median wage growth fell to 2.5%Y in March from 2.8% (Exhibit 8)

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Taking all that, and the bigger jobs picture in mind, what does the labor market mean for the Fed's June decision? The answer: it depends on whether you see the glass as half empty or half full.

The optimist says, "Well, the unemployment rate continues to fall and the Fed has been expecting the pace of job gains to slow. At 163k per month over the past 6 months, shown in Exhibit 2, the economy has been adding jobs well above the pace needed to keep the unemployment rate moving lower." The labor market is tightening, right?

The pessimist says, "Despite continued strength in the labor market, signs of labor market tightness are few and far between. Yes, the unemployment rate is falling, but core measures of wage growth remain anemic. Just look at the year-on-year rate of wage growth among production and non-supervisory workers, as shown in Exhibit 3. At 2.3% Y/Y in March, growth in wages of these workers was lower than it was in the year ending early 2014. This just means NAIRU (Natural Rate of Unemployment) is lower."

Morgan Stanely's summary:

"Even though NAIRU could be (much) lower, we don't think the FOMC consensus will let that affect their decision on rates for now. One weak headline payroll number is also unlikely to dissuade the consensus from believing that continued gradual rate hikes remain appropriate. However, if the April or May payroll number disappoints, that could change.... we'll be watching carefully for clues as to whether small business hiring slows in the wake of inaction by the Trump administration and Republican-controlled Congress. So we'll be watching with interest the NFIB Small Business Optimism index released on Tuesday, April 11."

What this means for markets and the economy: the Trump "reflation" rally, having already withered across many market indicators, has finally moved to the economy and actual wages, where it increasingly appears to have been nothing more than a mirage.

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