Those Jobs Numbers Disappointed, but They Didn't Tell Whole Story

For the second month in a row, U.S. payrolls have been a disappointment. The economy added just 194,000 jobs, which was more than 300,000 less than expected. So what does this mean for the economy going forward, and specifically for the Federal Reserve's plan to start tapering bond purchases next month? Here's my take.

Headline Job Gains Not as Bad as Appear

Yes, the headline job gain figure was well below expectations, but this comes with two huge caveats. First, there was an unusually large upward revision of 169,000 to the prior two months. Second, the pandemic continues to wreak havoc on seasonal adjustments. This time it was public school hiring. Overall state and local governments added over a million people to their education payrolls this month. But because that number is usually higher in September, it translated to a seasonally-adjusted loss of 140,000 jobs. But of course, these sectors didn't layoff as many people in June, either. Regardless, this 140,000 job loss doesn't say anything useful for the overall jobs picture. If we add back the upward revision plus this one-off "loss" in public schools, the overall jobs picture was right in-line with expectations.

Regardless, the headline job gain figure is less important than it used to be for two big reasons. First, historically this number has been a good gauge of demand for labor. Larger net job gains usually tells us that employers are eager to hire and vice-versa. But right now that's not in question. Labor demand is red hot. Labor supply is the big question.

Labor Shortages Are Real

These next two months are labor supply's last stand. Labor force participation has been stuck between 61.4% and 61.7% for over a year now, well below the 63.3% level just before COVID hit. This report showed participation ticked down slightly to 61.6% (from 61.7%) as 183,000 people left the labor force. This means that the functional labor supply is well below pre-pandemic levels, and moreover that those people sitting on the sidelines aren't currently responding to rising wages.

Six months ago, one could have blamed enhanced unemployment benefits for the slow labor supply recovery. There was hope that as these extra payments ended, labor supply would start rising rapidly. However, as of this payroll report that has expired nationwide. However even in the many states where the extra benefit ended early, there was very limited labor supply response. This argument is now officially dead.

Maybe the October report will show a rebound, but at this point I'm pretty confident in saying that the tight labor market we see now will persist as long as this expansion continues.

The only remaining case for why labor supply might get a sudden boost is child care. Many argued that perhaps when schools started again, that would be an impetus for people to start looking for a job. Given that the labor force actually shrunk this month, that argument is looking thin, as well. Maybe the October report will show a rebound, but at this point I'm pretty confident in saying that the tight labor market we see now will persist as long as this expansion continues.

Wages Are Critical, but Be Wary of Measurement 

For investors, wage pressure is the single most important element of the employment picture. Strong wage growth has two critical consequences. First of all, since labor is a universal cost input for firms, it creates an impetus for companies to raise prices. Second, higher wages mean more consumer income, which gives them the ability to actually pay higher prices. Basically without wage growth you can't get persistent inflation.

The problem is that the Labor Department's Average Hourly Earnings (AHE) measure isn't as helpful as it usually is. That's because the mix of hires keeps changing so wildly from month to month. Last month, the initial read was that hospitality sectors had almost no new hires. Since those sectors tend to be on the lower end of the pay scale, it skewed the average wage upward. That doesn't tell us what we really want to know, which is whether the average worker got a raise or not. This month wasn't as bad as last, but again restaurants and hotel hiring was relatively light, only about a 30,000 increase. And once again, AHE beat to the upside.

Regardless, we can be confident that wage pressure is quite high. We are hearing it anecdotally from companies across all sorts of sectors. I'm not sure we know exactly how high wage growth is, but it is strong and will continue to be strong as long as labor supply is tight.

Still Tapering 

There is going to be some debate among commentators about whether the Fed will still go through with tapering quantitative easing purchases in November. I believe they will, and if they defer, it will only be for one month.

The Fed can see everything we see: that labor supply is the problem, wage pressure is very strong, and overall inflation appears to be broadening. Continuing QE won't do any good for any of those issues. Moreover, QE is causing a lot of plumbing issues in the banking system. Banks are choking on the amount of reserves and deposits they have, and attempts to invest that money is flooding the short-term bond market. This is why the Fed's repo auctions have seen trillion dollar subscriptions in recent weeks. Add all this up, and QE is doing more harm than good.

Perhaps in an ideal world, the Fed would prefer to begin tapering after a stronger jobs number. But if QE has any effect on employment, it is that it boosts demand for labor. That isn't the problem now and the Fed knows it. The taper should go ahead regardless.

At the time of publication, Graff had no position in any security mentioned.