Analyzing The Employment Report

The employment report that was published on Friday was similar to the Q1 GDP report in that the headline number was "strong" and better than expectations while the numbers under the surface showed signs of continued economic deceleration. 

The headline payrolls number showed a gain of 263,000 jobs in April, above the 180,000 consensus estimate and the unemployment rate dropped to 3.6%. The unemployment rate fell mainly due to a decrease in the labor force participation rate, falling two tenths to 62.8%. 

Average hourly earnings, the worst metric in macroeconomics, was worse than expected and is showing "wage gains" of 3.2% year over year but this number was boosted because hours worked, the denominator of the fraction, fell faster than the numerator, pushing the ratio higher. "Average hourly earnings" has no correlation to consumer spending and typically rises in or around recessions as the hours worked component (the denominator) falls faster than the numerator. For the proper read on aggregate wage growth in the economy, a reading that actually correlates to consumer spending, we should be looking at the personal income & outlays report released by the BEA. Nominal wages & salaries growth, reported by the BEA, has decelerated from 5.07% year over year in August of 2017 to 4.20% today

Back to employment. The nonfarm payrolls headline number is also largely irrelevant. We should be looking at the trend in the year over year growth rate of employment. 

Total nonfarm payrolls growth showed sequential improvement, accelerating to 1.76% year over year, down slightly from three months ago and still well below the 2015 peak in employment growth. While employment is a lagging indicator, the deceleration into the 2015-2016 slowdown is clear, as is the reacceleration around the "Trump bump." 

While the headline number cannot be declared in a new phase of deceleration just yet, as we move to the underlying categories, employment growth has now followed the broader trend in the economy, one of deceleration. 

Total Employment Growth Year over Year:Source: BLS

The following charts will highlight various subcomponents to the report for production and nonsupervisory employees. 

Construction employment growth has decelerated more sharply than the headline figure. Similarly, a "Trump bump" can be seen with construction employment growth rising from roughly 2.50% year over year to 4.50% year over year. Albeit with some sequential improvement this month, construction employment growth is fading from the boost, dropping more than 100 basis points to 3.21% growth. 

Construction Employment Growth Year over Year (Production Workers):Source: BLS

Moving over to manufacturing employment, a highly cyclical sector shows a definitive deceleration in employment growth, falling from well over 2% year over year to 1.47%. 

Many comment that manufacturing is a shrinking share of the US economy and that is true, but manufacturing remains the most highly synchronized sector of the global economy. A cyclical downturn in manufacturing, not to be conflated with a secular decline in US manufacturing, is informative as it pertains to global manufacturing trends, global growth and the knock-on effects to US growth from a global manufacturing downturn. 

Manufacturing Employment Growth Year over Year (Production Workers):Source: BLS

Arguably more important as it pertains to forward-looking indicators is the length of the average workweek for production level employees. In the construction sector, the average workweek declined to 39.60 hours. 

Average Workweek Length (Production Workers - Construction):Source: BLS

If we aggregate the number of production level construction employees and the average workweek of construction employees, we get a reading on the aggregate hours worked in the construction sector. The year over year growth rate of this metric shows there were 2.17% more hours worked in the production level construction sector compared to one year ago. This may sound promising but all of the analysis I do is in rate of change terms. At the start of 2018, the construction sector needed nearly 6% more hours compared to the summer of 2017. 

The aggregate hours growth for the production level construction sector has decelerated from nearly 6% to the low 2% range, a marked deceleration which is consistent with the broad economic deceleration that we continue to outline. 

Aggregate Hours Worked (Production Workers - Construction) - Growth Rate:Source: BLS

The decline in the average workweek for the manufacturing sector, a more cyclical sector, is much more pronounced. While the average workweek for production level manufacturing employees remained flat sequentially, there has been a marked decline from the start of 2018 when the global economy and the global industrial sector peaked. The average manufacturing workweek remains a component of nearly all popular leading indexes and this measure continues to point to manufacturing weakness. Towards the end of this report, we will dig even deeper and highlight the root cause of the manufacturing decline; the auto sector. 

Average Workweek Length (Production Workers - Manufacturing):Source: BLS

Using the same analysis as above, we can tabulate the growth rate in the aggregate manufacturing hours needed. At the start of 2018, the peak of the global economy, the US manufacturing sector required 2.98% more hours than at the same time one year prior. Today, aggregate hours growth is negative which suggests the manufacturing sector may move into contractionary territory. 

More important than the nominal number of -0.21% year over year growth is the pace of the decline from April of 2018 through today. Looking at the right-hand panel which shows the long-term picture shows just a few periods of time in which there was such a rapid decline. 

Aggregate Hours Worked (Production Workers - Manufacturing) - Growth Rate:Source: BLS

I don't judge the strength of the employment report by any headline metric or subjective opinion but rather what the employment report did to the year over year growth rate in my leading employment index, most specifically the six-month trend. The softening of the internal metrics has been well forecast by this index and the corresponding pressure on interest rates. 

The leading employment index has various components from the employment report, the most cyclical and leading metrics, in addition to initial jobless claims. 

The leading employment index suggests that the internal metrics of the report will continue to soften, in time posting decelerating headline numbers which will come as a surprise to the consensus although the declines have been occurring for many months. The leading employment index also forecast the acceleration in employment growth through the balance of 2018. 

Leading Employment Index Year over Year (%):Source: BLS, DOL

If we sum the average weekly hours for production workers in the manufacturing sector, plus the average overtime hours for production workers in the manufacturing sector, we can get a reading on exactly how many hours the average production level manufacturing employee worked. 

The year over year change in this figure is declining at a precipitous rate. This alone is not enough to call for a slowdown or a recession or anything else that economic bulls use to strawman a factual argument but this rate of decline is noteworthy when coupled with declines in consumer spending, industrial production, and other sectors of the economy. 

As a reminder, we are focused on the rate of change, or the second derivative. 

Average Weekly Hours + Overtime Hours For Production Workers: Manufacturing (YoY %):Source: BLS

A few weeks ago, I highlighted the auto sector as one of the areas of the entire global economy that was responsible for the global manufacturing downturn. That thesis continues to develop and strengthens as more data unfolds. 

The following chart shows the average weekly hours plus overtime hours for production level employees in the transportation sector. The nominal hours are presented on the right-hand axis in bar chart format while the year over year growth rate is on the left-hand axis in line chart format. The past four months have shown a rapid decline in the hours worked in the transportation sector, something dragging the aggregate manufacturing sector lower. 

Average Weekly Hours + Overtime Hours For Production Workers: Manufacturing - Transportation:Source: BLS

Going one layer deeper, into the motor vehicles sector, shows an even more pronounced decline in total hours worked. The year over year decline in total motor vehicle hours is exceeding 3.70% year over year and the declines are accelerating in recent months. 

Average Weekly Hours + Overtime Hours For Production Workers: Manufacturing - Motor Vehicles:Source: BLS

If we strip out overtime hours and look solely at full-time hours worked in the motor vehicle sector, we see declines in excess of 4% year over year and a precipitous decline in the nominal hours worked. 

Average Weekly Hours For Production Workers: Manufacturing - Motor Vehicles:Source: BLS

The average weekly hours always leads broader employment because it is less binding and less costly to reduce hours worked than to layoff and rehire new employees when there is a shift in demand. 

If hours worked decline and demand does not rebound, the only next step is to lay off workers. 

In the past six months, we have seen four monthly declines in motor vehicle production level jobs and the year over year growth rate has moved negative. This highlights that there are less motor vehicle employees today than the same month last year, something that has not happened other than for one month in late 2016. 

Production Employment - Motor Vehicles (%):Source: BLS

The decline in the auto sector is absolutely clear. I will continue to monitor this sector and we are likely to see further declines in auto production which will drag industrial production lower. 

Economic decelerations always emanate from sectors in which pent-up demand has been exhausted and radiate to other sectors of the economy. In the US, a recession typically does not occur unless the slowdown in manufacturing spreads into the service sector. The service sector remains healthy although there have been some signs of weakness, specifically the most recent ISM non-manufacturing index. 

ISM Non-Manufacturing:

Source: Bloomberg

Sticking true to form and only focusing on the rate of change, shows the ISM services index declining from 61.6 to 55.5. Many will say the ISM is still "good" but that is an opinion. Decelerating or accelerating is a fact-based approach. 

Is the employment slowdown moving into services? That remains unclear at the moment but we do have the start of a more pronounced deceleration in the employment component to the ISM services index. 

ISM Non-Manufacturing - Employment:Source: Bloomberg

I am not calling for the employment slowdown in services to start showing up in the employment report based on one ISM metric. 

My forecast remains for a continued decline in the manufacturing sector, including employment, that is most specific to the auto market. 

A more severe economic slowdown will materialize should the auto market and manufacturing decline spread into the service sector. 

This same set up occurred in 2015 and a recession was avoided as the US service sector decline was not sufficiently pronounced. 

We will continue to monitor these trends, specifically the auto sector slowdown which has empirically accelerated to the downside. 

Interest rates continue to respond to the rate of change in economic growth, confounding the consensus opinion that rates should be rising. I will leave the short-term call on interest rates to others but in this environment, one of an empirically observable economic deceleration, interest rates may rise temporarily but they are not likely to stay elevated without a re-acceleration in broad-based nominal growth.