Nonfarm payrolls rose by 223,000 in the initial estimate for May, stronger than expected, but not statistically outside of the moderately strong trend of the last year. We need a little less than 100,000 jobs per month to absorb new entrants into the workforce. Hence, it’s no surprise that the broad range of data has indicated a further tightening in labor market conditions. The unemployment rate, 3.8% in May, is trending lower. Measures of underemployment are falling. Obviously, that can’t go on forever. Wage pressures still appear to be moderate overall, although salary increases are more apparent for skilled labor positions, and we can probably expect faster wage growth in the months ahead. This creates a dilemma for the Fed.
There’s always a fair amount of noise in the monthly payroll estimate (as reflected in the chart below). Seasonal adjustment can be tricky, but the underlying trend has remained relatively strong this year. We know that demographic changes (the aging of the population) imply significantly slower growth in the labor force than in past decades (when the baby-boomers were entering, female labor force participation was rising, and immigration was higher). Job growth has to slow as the U.S. runs out of people to hire. That hasn’t happened yet, as there appears to have been greater slack than previously thought. Fed officials fear that the unemployment rate has fallen below a level consistent with normal underlying frictions in the labor market. Initial claims for unemployment benefits, for example, have been trending at multi-decade lows (impressive, in that the labor force is twice the size that it was in the late 1960s).
Nobody knows what the natural rate of unemployment is. In the past, unemployment rates of around 4% have been associated with pending recession. That’s because the Fed’s attempts at slowing the economy typically result in a harder landing than expected. Alternatively, the central bank may have waited too long to tighten and was forced to move more aggressively later on (this is the main argument behind the Fed’s current path of gradual rate hikes).