Walter Molano | Labour pains and inflation’s shadow

The April employment report in the United States was completely unexpected, and it created a maelstrom of commentary.

The number was expected to be strong, with analysts calling for the creation of one million new jobs. However, the number came in much weaker, at 266,000 new jobs.

To begin with, the employment report is very noisy with constant revisions by the US Labor Department. Exogenous forces were also at play. Employment was down in car manufacturing due to the computer chip shortages that have been repeatedly discussed in the mainstream media.

Chip manufacturers had cut back on production, expecting a prolonged recession. Traffic at US ports, along the West Coast, had slowed due to COVID restrictions. Furthermore, the proliferation in the use of computer chips across a myriad of consumer products pushed demand well above output.

There were also problems in the retail sector. Retailing continues to suffer, as the online shopping phenomenon transforms the market. This segment represents 6.3 per cent of total employment. Yet, there were other factors that are reshaping the labour market.

The labour pool has been hit by demographic forces. The demographic changes that were shrinking the labour force prior to the onset of the pandemic only got worse. A recent study by the Pew Research Center found that the pace of retirement doubled in 2020 over 2019.

The deep recession, early retirement programmes and health concerns convinced many older workers to leave the labour force. This was on top of the carnage that the disease has wreaked on the ‘baby boomer’ generation. More than half of the almost 600,000 US deaths that occurred during the pandemic were in this age group.

On top of that, immigration flows have fallen. Four years of anti-immigration policies in the US, travel restrictions and complications curtailed the arrival of legal and illegal migrants, reducing the labour pool. Moreover, there were less college graduates entering the workforce. Not only did enrolment sink by more than 10 per cent, many seniors took a gap year to delay their graduation. There was also a 43 per cent decline in international students.

However, the most controversial issue was the generous unemployment programmes that may have acted as a disincentive for many job applicants. Many people found it more lucrative to remain in the unemployment ranks, rather than take a low-paying job. This raised a howl from the political right, with pundits screaming that the handouts from the Biden administration were destroying the economy.

The funny thing is that the May employment report will be even more controversial because it will reveal the full effect of the stimulus programme.

The cheques were not mailed or deposited until the end of April. Therefore, the pickup in economic activity did not take full effect until May. The May data will show a much bigger impact of the increased demand for workers, and we should also see how much the higher benefits induced potential workers to stay at home.

At play is the inflation rate. Tighter labour markets will force businesses to raise wages in order to lure back workers. There are already anecdotal stories of generous signing bonuses and perks.

With the pace of economic activity expected to jump more than 7.2 per cent this year, marking the fastest expansion in 37 years, employers will be able to pass on the higher labour costs on to consumers. Rising commodity prices are also taking their toll, and pushing up transportation and production costs.

The Bureau of Labor Statistics reported that consumer prices soared 4.2 per cent year-on-year in April, more than twice the Federal Reserve’s target. Meanwhile, producer prices spiked 6.2 per cent during the same month. Both numbers were much higher than expectations.

Like the employment report, the inflation data will be worse in May. Not only will the full effect of the stimulus be felt, but the disruptions caused by the shutdown of the Colonial Pipeline will also affect the data. Not only did the pipeline supply gasolene for about half of the Northeast, it was the main source of fuel for much of the American South.

States, such as North Carolina and Virginia, virtually ran dry for days. This stranded motorists. It disrupted supply chains and led to shortages of many consumer products, as truckers were stranded without fuel. Even the US Navy was concerned that it would not have enough fuel to keep its Atlantic fleet at sea.

Nevertheless, the Fed firmly believes that the inflationary spike will be temporary, and there will be no need to raise interest rates. It would rather err on the side of higher inflation, rather than derail the recovery with a taper tantrum.

For now, the bond market is giving it the benefit of the doubt, with the yield on the 10-year bond firmly at 1.62 per cent. However, we need to see how patient investors will be when the May data is released and whether all of this patience was just a labour of love.

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com