by Rick Rieder
The April employment report confirmed what we’ve been thinking for a while: There’s a disconnect between the jobs market and economic improvement overall.
Of course, harsh winter weather weighed on the labor market recently, as well as on GDP growth, but we’d expect broad economic improvement and supportive financial conditions to promote greater investment and hiring. We saw that to a degree Friday, with nonfarm payrolls coming in 288,000 higher, an encouraging gain. But other elements of the employment report were more disappointing, and point to deeper troubles. For instance, the civilian labor force dropped by 806,000, following its rise in March, and the labor force participation rate declined markedly by 0.4% to a new low of 62.8%. When combined with a continued rise in temporary workers (24,000 higher), we think this data underscores the fact that a more complicated dynamic is at play.
This is an odd phenomenon: Companies have largely completed their post-crisis deleveraging and have access to historically cheap credit, but they continue to build up piles of cash.
Why would this be? There are a few factors to consider.
First, the benefits of Federal Reserve accommodation have reached their limits. Although quantitative easing is on the way out, it overstayed its welcome and has distorted capital allocation decisions profoundly. As we assess the value of Fed policy, it’s important to remember we’re not where we were five years ago.
During the crisis and aftermath, QE and related Fed policy was providing both liquidity and an element of certainty, since credit was paralyzed and needed a jump start. Fed policy is still providing that same liquidity, but today, it’s actually creating risks to financial markets. We believe markets and companies today are capable of functioning perfectly well on their own, but there’s still a $45 billion-a-month elephant in the room, and a funds rate sitting at the zero bound.
What does this mean for jobs and growth? You’d imagine low rates would encourage hiring. Except that companies can’t quite figure out what the economy will do when the elephant finally leaves the room – and when interest rates move to more normal levels. They’re waiting out the uncertainty instead of making investments.
Structural issues hit hiring
This brings us to the second problem. Let’s imagine a world in which QE has made a graceful exit, markets are stable, and companies are eager to spend. Would employment rise? The answer is yes — but not as much as many think. Just as Fed policy isn’t the cure to all of our problems, it’s not necessarily the source of them all either. In truth, there are significant structural, not cyclical, obstacles to higher employment.
One such obstacle is increased (and increasing) longevity. Global life expectancy has grown 50% since 1950 and 30% just since 1980. People are staying in the workforce longer both because they are healthy enough to do so, and because longer retirements mean they need to save more. And these longer careers mean younger workers are being crowded out of the workforce, the normal velocity of employment is being compromised.
The problem is further exacerbated by today’s low-rate environment, as the savings of these older workers aren’t yielding enough to allow for a realistic retirement. But ultimately, an end to QE won’t change the fundamental dynamic. Today’s artificially low rates are only temporary, but longer lives are here to stay. As longevity continues to increase, people will stay in the workforce even longer, which will continue to put pressure on younger workers.
That’s not the only problem. Even if the older workers retired, would they be replaced — or need to be replaced — by younger ones? Technology is stripping jobs out of the economy, as more work can be done by fewer people. The rise of technological substitution raises an additional obstacle, which is the skills mismatch: The roles many workers are trained for are disappearing, and there aren’t enough trained people to do the jobs of the technologized economy.
Since we’re well past the time when Fed policy can make a positive impact, hiring won’t accelerate without the benefit of fiscal policy — in the form of training and education, research and development tax credits, or direct capital expenditure or hiring incentives (which could be spurred on by a nominal tax holiday directed at capital expenditures or hiring for overseas trapped cash). Will those policies materialize? It’s difficult to say, because if you think monetary policy is unpredictable, fiscal policy is a whole other ball of wax.
What does this all mean for investors?
No change to corporate behavior (or fiscal policy) will come quickly, so we should expect increased pressure on companies to spend their excess cash, and investors should watch for activists to continue trying to extract it through share buybacks and dividend increases.
Additionally, investors should be able to expect further asset price inflation -- although now likely with a good deal more volatility. Low rates over the past few years encouraged people to seek out risk assets (such as equities and high-yield bonds), and while those assets appear to be priced fairly right now, the longer QE continues, the greater chances a bubble will start to build.
What’s clear is that a committed taper, although it won’t vastly affect employment, will at least decrease market distortions and provide some much-needed clarity over the path of policy.
Rick Rieder is chief investment officer of Fundamental Fixed Income and portfolios co-head of Americas Fixed Income at BlackRock.