Monetary Strategy: The Labor Market Rules

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Last Friday, we heard fresh sounds from two international finance bully pulpits.

Fed Chair Janet Yellen spoke on the U.S. labor market situation. The state of the U.S. labor market will determine the path of U.S. rate hikes. Mario Draghi spoke at Jackson Hole, too. He explained future policy stimulus available to Europe.  

What did we learn?

First, Janet Yellen is using her new-fangled “dashboard” -- a 19-indicator Labor Market Conditions Index (:LMCI) to gauge the amount of U.S. labor market slack.  

She summarized the LMCI index rests at 290. Before the crisis, the LCMI was 370. Plenty of slack exists. Wage inflation is happening to parts of the U.S. economy now. Opposing forces -- in other parts -- moderate its influence on the broad U.S. economy.

According to Bloomberg, here is what a few LCMI indicators showed --

Positives arguing for a faster and more rapid rate hike:

(1) Layoffs/discharges are lower than pre-recession (2004-07) averages.
(2) Job openings are at a 13-year high.
(3) Non-farm payrolls are trending higher. The U.S. averages +245K a month now, versus +162K before the recession.

Neutral factors arguing for the consensus Q1-15 rate hike:

(4) The unemployment rate at 6.2%. That’s just above a 5% pre-recession average.
(5) The hire rate is 3.5%. That’s just below the 3.8% pre-recession average.

Negatives factors pushing back the timing of a rate hike:

(6) The so-called U-6 unemployment rate. This index includes part-time workers who want a full-time job and those not in the labor force.
(7) The long-term unemployed (those out of work over 27 weeks) share is at 32.9%, versus 19.1% before the recession.
(8) The labor force participation rate is 62.9% versus 66.1% before the recession.

What insights can I add?  

All labor markets have a ‘dual’ character. There are high-paying permanent jobs with benefits on the first tier. On the second tier, there are hourly, part-time jobs that require less education.

The way recessions (and bosses) work is companies under stress throw the “2 of Spades” and “Keep the Aces.” The boss pushes the weaker, less-skilled, more malleable and less desirable workers out first. These second tier workers then stay in unemployment longer too.

If you are on the fourth line, you go first and come back last!

In ice hockey terms, the coach keeps the first and second lines, so the team can still play the game. The coach lets go the third and fourth lines. They are a luxury under stress. You re-employ them when times are better.

Here’s what the U.S. economic condition shows today: things are good enough now to bring back the third line, but not the fourth line. The fourth line still sits in the stands and watches the game, getting rusty, getting poorer and getting annoyed.

According to the LMCI, if a worker has needed technical skills, there hasn’t been a better U.S. jobs market for you in 13 years. If a worker has been unemployed for six months or more, in part-time work accumulating weak skills, and has a poor education, the same level of U.S. activity feels awful.

How about across the pond?

According to the Financial Times, there was a significant change of tone from Mario Draghi. He said European Union countries should be encouraged to spend more and tax less. Under existing rules, budget deficits are limited to -3% of GDP in Europe’s Union. That implies Germany has some room to spend more and tax less. The Italians (Mr. Draghi is Italian) are already moving ahead with talk of more spending and less taxes. France must be in the same “spend more and tax less” camp.

Mr. Draghi thinks more easing from Europe’s central bank needs to accompany more spending, less taxes and deeper structural reforms across the many states of Europe. Otherwise, any action from him won’t provide added stimulus.

Deeper structural reforms he talks about would let a firm hire and fire its workers more easily. The Eurozone unemployment rate is 11.5%. The U.S. rate is 6.2%.

Agreed, a part-time job is not great. But you can get a part-time job in the U.S. more easily than in Europe right now. Here is where Mr. Draghi's and Ms. Yellen's minds meet -- In the labor market.


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