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Weekly Commentary by Dr. Scott Brown

Not Quite as Anticipated
August 25 – August 29

In her Jackson Hole speech, Fed Chair Janet Yellen presented a balanced look into the issue of labor market slack and how monetary policy should respond over time. While there is plenty of slack currently, the bigger questions are how rapidly that slack will be taken up and how the Fed should position monetary policy in response. Yellen offered no clear answers.

In past months, Yellen emphasized that the Fed is looking at a broad range of labor market indicators, not simply the unemployment rate and nonfarm payrolls. However, in her Jackson Hole speech, she noted that “estimates of slack necessitate difficult judgments about the magnitudes of the cyclical and structural influences affecting labor market variables, including labor force participation, the extent of part-time employment for economic reasons, and labor market flows, such as the pace of hires and quits.” Recent research suggests that the behavior of these and other labor market indicators have changed since Great Recession.

Yellen noted a “convenient way to summarize” the various labor market indicators. The Fed’s Labor Market Conditions Index, derived from 19 labor market indicators, “supports the conclusion that the labor market has improved significantly over the past year, but also suggests that the decline in the unemployment rate somewhat overstates the improvement in overall labor market conditions.”

Yellen had apparently read beforehand the research papers presented at the KC-Fed’s monetary policy symposium, as she incorporated some of the key findings into her speech. Notably, the labor market is significantly less fluid, reducing employment opportunities, keeping unemployment higher, reducing productivity growth, and limiting wage growth.

Another possible explanation for the weak recovery in the labor market is the concept of polarization — growth in high-education, high-wage jobs, growth in low-education, low-wage jobs, and not much in between. One of the papers presented in Jackson Hole makes a compelling argument that this bifurcated labor market phenomenon is due less to technological change and more to globalization and the aftermath of the housing collapse. This need not be permanent, but adjustments are likely to be slow, costly, and disruptive (more on this next week).

A key issue in labor market debate is how much of the soft labor market recovery has been cyclical and how much has been structural, and whether cyclical weakness may be turning into structural weakness. Yellen noted that “despite challenges in assessing where the share of those employed part time for economic reasons may settle in the long run, the sharp run-up in involuntary part-time employment during the recession and its slow decline thereafter suggest that cyclical factors are significant.” Moreover, “the balance of evidence leads me to conclude that weak aggregate demand has contributed significantly to the depressed levels of quits and hires during the recession and in the recovery.”

“The pattern of subdued real wage gains suggests that nominal compensation could rise more quickly without exerting any meaningful upward pressure on inflation.” And, “since wage movements have historically been sensitive to tightness in the labor market, the recent behavior of both nominal and real wages point to weaker labor market conditions than would be indicated by the current unemployment rate.” However, Yellen went on to suggest three reasons to be more cautious. One is that firms may have had difficulty in cutting wages during the downturn. This “pent-up wage deflation” may be leading to more modest increases in nominal wages currently. Second, weak wage growth may reflect secular trends, such as changing patterns of production and international trade (and possible measurement issues). The third possibility is that dislocations from the Great Recession may be leading to a more permanent lower trend in wage growth, as those dropping out of the labor force may face a difficult time coming back.

Turning to monetary policy, Yellen noted that given the “substantial” degree of slack in recent years, “the need for extraordinary accommodation is unambiguous.” However, Fed policymakers are “naturally shifting to questions about the degree of remaining slack, how quickly that slack is likely to be taken up, and thereby to the question of under what conditions we should begin dialing back our extraordinary accommodation.” As Yellen noted there are dangers in raising rates too soon as well as too late. “There is no simple recipe for appropriate policy in this context.”

A Roadmap, Not a Timetable
August 18 – August 22

On Friday morning, Fed Chair Janet Yellen will deliver the keynote address at the Kansas City Fed’s annual monetary policy symposium in Jackson Hole, Wyoming. Those looking for clues on the timing of the first Fed rate hike are likely to be disappointed. As Yellen previously noted, “it depends.” Yellen’s speech should provide insight into how the Fed views the current labor market situation and, more importantly, how monetary policy will respond to changing job conditions as it begins to normalize monetary policy in the months ahead.

We can expect Yellen to address many of the key topics in the labor market and Fed policy debates. Specifically, how much slack remains in the job market? What drives compensation gains; is it overall unemployment, short-term unemployment, measures of under-employment? How much of an increase in wage inflation is the Fed willing to tolerate and for how long?

We already have some indication of how Yellen will characterize the job market. While the unemployment rate has fallen significantly from its recessionary peak, a lot of that is due to a decrease in labor force participation. Some of the decrease in participation is demographics, reflecting the aging of the population. However it’s also likely that the job market is a lot more flexible that most people think.

The Bureau of Labor Statistics Business Employment Dynamics (BED) data don’t get much attention from the financial markets. They arrive with a lag (we currently have information up to 4Q13). The monthly employment report is by far the most significant of the monthly economic data releases. However, the monthly payroll estimate is a net figure. Millions of jobs are gained and million are lost each quarter, partly reflecting seasonality (the school year, the holiday shopping season). The BED data are gross measures. The recovery from the Great Recession can be characterized as a period of relatively low job destruction and a gradual uptrend in job creation.

Job losses were consistently higher in the previous expansion, but so was job creation. The BED data paint a remarkable picture for the late 1990s. At the time, job losses were very high, but job creation was even higher. It was a transformative time. Cell phones, the Internet, and computer networking transformed the way businesses operate. We also learned that the job market was a lot more flexible than previously believed. While some blame the Fed for inflating the tech stock bubble, monetary policy facilitated a lot of the transformation. Workers moved up, and those on the margins came in to fill the gaps. Lured by more attractive wages, retirees and stay-at-home spouses returned to the job market.

During the next decade, we saw the downside of the new technologies as firms could do more with fewer workers. The initial rebound from the 2001 recession was a “job-loss” recovery. We didn’t begin to add jobs until nearly two years after the recession had officially ended.

The Great Recession (or if you prefer, the Lesser Depression) was not your typical economic downturn. Given the collapse in the housing sector and a massive deleveraging of the financial sector, there was never going to be a quick turnaround. The low level of job turnover has been a chief characteristic of this recovery. The housing collapse had a lot to do with that. Tied to their underwater mortgages, workers are less inclined to pull up stakes and pursue employment in other parts of the country. Quit rates are trending higher, but only gradually. There’s much less job hopping than there was in previous cycles.

The low labor turnover rate is associated with the relatively weak growth in wages. Weak wage growth in turn limits the pace of growth in consumer spending (and thus, the overall economy). While income inequality has been an important topic this year, most of the focus has been on high-end salaries rather the struggles of the middle class and below. The focus is starting to change. One can easily observe the impact of the squeeze on the middle class in retail sales and housing.

What will reverse the week trend in wage growth? A tighter job market. A recent Chicago Fed letter suggests that there is a strong correlation between real wage growth and medium-term unemployment (those out of work for 5-26 weeks), as well as with marginally attached workers, particularly those working part time involuntarily for economic reasons.

The more interesting question is how long the Fed will be willing to tolerate a pickup in wage growth, but we first have to see that pickup before we worry about tighter policy.

Yellen’s speech is likely to suggest that there is still ample slack in the job market and to imply that the Fed will be in no hurry to raise short-term interest rates.



How Much Slack Is There In the Job Market?
August 11 – August 15

The amount of slack in the labor market will be a key driver of monetary policy in the months ahead. Fed officials differ in their perceptions of job market slack, leading some to want to tighten policy sooner rather than later. Labor market data can present somewhat different pictures, but on balance, there is still a large amount of slack remaining.

Weekly claims for unemployment insurance have been trending at very low levels, consistent with a limited pace of job destruction. Short-term unemployment is now at a “normal” level, consistent with the usual labor market frictions of a fully recovered job market. However, long-term unemployment and measures of underemployment remain elevated.

Labor force participation is the lowest since the 1970s. About a third of the decline since the recession began is due to demographics, the aging of the population. However, most of the decline is due to individuals who have given up looking for a job. However, as we learned in the strong job market of the late 1990s, the labor force is a lot more flexible than you might think. Rising wages could easily lure recent retirees and stay-at-home spouses back into the labor force.

Surveys of hiring intentions have shown gradual improvement in recent years, but remain below normal. Job turnover data reflect an uptrend in hiring, but not a strong one. Geopolitical tensions could lead to business caution in the remainder of the year, restraining growth in capital investment and the pace of hiring. The percentage of workers quitting to find new jobs has picked up over the last year, but remains below normal.

Despite a modest uptick in 2Q14 (which followed weather-related weakness in 1Q14), labor compensation has been trending at a lackluster pace, consistent with a high level of slack in the job market. Fed Chair Janet Yellen has indicated a willingness to accept some pick up in average wage income before having to tighten monetary policy.

In short, while the job market has improved significantly this year, it still has a long way to go for a full recovery. Fed policymakers should be willing to let the job market run.



The opinions offered by Dr. Brown should be considered a part of your overall decision-making process. For more information about this report – to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy – please contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you today.

All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates (RJA) at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete. Other departments of RJA may have information which is not available to the Research Department about companies mentioned in this report. RJA or its affiliates may execute transactions in the securities mentioned in this report which may not be consistent with the report's conclusions. RJA may perform investment banking or other services for, or solicit investment banking business from, any company mentioned in this report. For institutional clients of the European Economic Area (EEA): This document (and any attachments or exhibits hereto) is intended only for EEA Institutional Clients or others to whom it may lawfully be submitted. There is no assurance that any of the trends mentioned will continue in the future. Past performance is not indicative of future results.

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