Employment Report: Under The Hood

The employment report released last Friday showed material weakness behind the headline addition of 164,000 jobs. This is not a subjective characterization of the popular employment situation report but rather an objective description based on the change in the direction of the leading employment index. 

More important than the month over month change, the year over year growth rate of total employment decelerated again to an 18-month low of 1.51%. 

While mainstream pundits still classify economic data points, including the jobs market with opinion-based descriptions such as "good", "solid" or "tight", fixed income market participants have observed seven months of deceleration in labor market growth. 

Total Employment Growth Year over Year:Source: BLS, EPB Macro Research

Several months ago, the US economy was adding 236,000 jobs on a six-period average. That rate has fallen to a level of 141,000. Many are still considering this rate of job creation to be "good" rather than taking note of the deceleration in the pace of employment gains. 

Total Employment Monthly Change: 6 Period AverageSource: BLS, EPB Macro Research

The leading employment index, which contains the most cyclical components of the jobs market and data from three surveys including both the establishment and household survey, has decelerated to the slowest growth rate of this economic cycle. 

The leading employment index has a 4-8 month lead over the rate of change in nonfarm payrolls growth which means the rate of employment growth, or the pace of 141,000 jobs, is likely to continue moving lower. 

Herein lies the problem. Once job creation slows to a level that mainstream pundits consider "bad", say perhaps less than 100,000, the bond market will have already moved hundreds of basis points. 

While consensus continues to look at economic data in terms of "good" or "bad", those focused on the rate of change have experienced a greater than 30% rally in the long-bond (TLT) (EDV), entirely due to this decline in the rate of growth and inflation.  

Leading Employment Index Growth Rate (%):Source: EPB Macro Research

Under the hood, the average weekly hours worked for all production workers has dropped to 33.5. A decline in hours worked historically, and logically, precedes a decline in the number of people employed. 

Average Weekly Hours: Production WorkersSource: BLS, EPB Macro Research

A common leading indicator, the average manufacturing workweek, has shown sharp declines the past several months, moving to a 94-month low. 

Average Weekly Hours: Production Workers (Manufacturing)Source: BLS, EPB Macro Research

If we aggregate the average weekly hours + overtime hours for production workers in the manufacturing sector, we see a peak-to-trough decline of 3.4% in average weekly hours and a multi-year low.

Average Weekly Hours + Overtime Hours: Production Workers (Manufacturing)Source: BLS, EPB Macro Research

The growth rate in the total weekly hours for production manufacturing workers has moved to the lowest rate since 2010. 

Average Weekly Hours + Overtime Hours: Production Workers (Manufacturing) Growth Rate (%)Source: BLS, EPB Macro Research

Aggregate hours worked for production workers, or the total number of workers times the average weekly hours is only up 0.71% compared to last year. 

This means, for production workers, the economy only needed 0.71% more hours than last year, down from a growth rate of 2.75%. 

If the economy needed 2.75% more production hours, but now only 0.71% more production hours, the direction of total output will certainly decline. 

Aggregate Hours Worked: Growth Rate (Production Workers)Source: BLS, EPB Macro Research

In terms of manufacturing, the industrial sector of the US economy was requiring nearly 3% more production hours at the start of 2018. Today, the growth rate in total hours for manufacturing is negative, highlighting the contraction in this sector. Fewer hours are needed today than one year ago. Unless productivity has surged, total output in this sector will decline. 

 Aggregate Manufacturing Hours Worked: Growth Rate (Production Workers)Source: BLS, EPB Macro Research

Claiming this economic slowdown is localized to manufacturing is also a mischaracterization, evident by the 35-month low on today's ISM Services index. 

Furthermore, the cumulative production hours needed in construction has declined from a growth rate of nearly 7% to a growth rate of just 1.51%. 

Aggregate Construction Hours Worked: Growth Rate (Production Workers)Source: BLS, EPB Macro Research

The leading index of employment, which carries a reliable lead over the year over year growth rate in employment, suggests more deceleration in employment growth will occur over the next several months. 

This forecast is also highly consistent with the commentary from both IHS Markit PMI reports and ISM PMI reports. 

The growth rate in total employment is decelerating, as is the average weekly hours worked. Together, the growth rate in total hours worked in the economy is falling. 

Unless productivity is rising rapidly, a sharp decline in the aggregate production hours worked in the economy ensures lower rates of economic growth relative to prior quarters. 

This decline in the rate of economic growth, and also inflation, while noise to some, will continue to bring lower rates across the Treasury curve, and divergences among cyclical and defensive sectors.