October Employment Report Does Not Change the Fed's Issue

The October Employment Report should sustain expectations of a December Fed rate hike.  But, the Report does not change the issue faced by the Fed -- economic strength is not translating into significantly higher inflation.  Upcoming reports on the October and November CPI remain important with regard to what the Fed does or says at its December FOMC Meeting.

The +250k m/m October Payrolls keeps the 3-month trend in Payrolls above 200k, arguing for additional tightening.  But, the jobs strength is pulling people into the labor force, meeting the higher demand for labor and mitigating the pressure on wages.  The Labor Force Participation Rate rose in October, keeping the Unemployment Rate steady at 3.7%.  Some of the increase could have been sampling noise.  Nevertheless, the steadiness in the Participation Rate so far this year runs counter to its demographically-related downtrend -- as Fed Chair Powell keeps pointing out.

The 0.2% m/m increase in October Average Hourly Earnings could have been held down by calendar and composition effects.  It is in line with the average m/m pace seen this year.  The y/y rose to 3.1% because of base effects -- AHE temporarily fell 0.2% in October 2017.  AHE rebounded in November (+0.2%) and December (+0.4%)  2017.  But, calendar considerations suggest 0.3% for November and December 2018, which would keep the y/y at 3.1% by year end.

While wage rates have sped up a bit, the broadest measure of labor costs -- Compensation/Hour -- shows a more subdued trend.  And, the wage increases may not be inflationary, since a speedup in productivity has slowed Unit Labor Costs.

Labor Cost inflation is slowing, according to its broadest measure.   Compensation/Hour has slowed so far this year relative to its 2017 pace.  While both years' paces are above the rate of increase in 2016, this year's difference is almost fully offset by stronger productivity.   As a result, Unit Labor Costs are up only slightly more than they were in 2016.  It is one reason the Core PCE Deflator has risen close to the 2016 pace so far this year.  (The Deflator's 2017 slowdown reflected in part a price war in the telephone industry -- margins were cut.)

                                                  (percent change over the year)
                Compensation/Hour      Productivity       Unit Labor Costs     Core PCE Deflator
2018 *                 3.1                              1.8                              1.2                          1.9
2017                    3.4                              1.1                              2.2                          1.6
2016                    1.1                              0.1                              0.9                          1.8

*  over the first 3 quarters, annualized