UNIQA Capital Markets Weekly

USA
• Strong labor market in June although some indicators still suggest only moderate wage growth
• Fed Chair Yellen’s semi-annual testimony at congress with cautious note on inflation and remarks on the ‘neutral’ level of the fed funds rate and balance sheet normalization

Total nonfarm payroll employment increased by 222,000 in June, the U.S. Bureau of Labor Statistics (BLS) reported on Friday July, 7th (Figure 1). Employment increased in health care, social assistance, financial activities, and mining. Employment growth averaged 180,000 per month thus far this year, in line with the average monthly gain of 187,000 in 2016. In addition, new jobs in June beat Bloomberg analysts’ expectations (178,000) and were revised upwardly for April (from 174,000 to 207,000) and May (from 138,000 to 152,000).

The unemployment rate was little changed at 4.4 % in June. Since January, the unemployment rate is down by 0.4 percentage points and below what is widely considered as the longer-run, structurally determined unemployment rate (f. ex. 4.6 % per the latest Federal Reserve economic projections).
Earnings growth came in below expectations. Over the year, average hourly earnings rose by 2.5 % in June; mostly in line though gradually below the recent trend growth in earnings. Given tight labor market conditions and, hence, rising employees’ bargaining power, economists have been waiting for wage growth to accelerate.
The year-over-year growth in the average wage level in the employment report is influenced by wages paid to people who were employed either today or a year earlier. That is, the wages of those who remained employed as well as those who entered employment and those who exited employment. Because the individuals in these three groups may command different wages on average the usual wage growth measures confound the effects of changes in the average wage of people with particular types of y-o-y employment histories. People who enter and exit employment may, for example, have a lower average wage than those who stay employed over the year. The wage tracker that was developed by the Federal Reserve Bank of Atlanta ignores the entry/exit margin. It only looks at people who are employed both today and a year earlier and thereby better neglects cyclical fluctuations during recoveries and recessions. In fact, an adjusted time series would show wage growth beyond 5 % in Q1 2017 as compared to the overall wage tracker and average hourly earnings from the employment report (Figure 2).

Last week, Fed Chair Janet Yellen presented the Federal Reserve’s semi-annual Monetary Policy Report to the Congress. Yellen confirmed that the labor market has continued to strengthen since here appearance before the Committee of Financial Services in February. The economy appears to have grown at a moderate pace, so far this year. Recent indicators suggest that growth rebounded in the second quarter after it had grown by 1.5 % (q/q, annualized rate) in Q1 2017. 
With regards to inflation, Yellen said that it appears that the recent lower readings are partly the result of a few unusual reductions in certain categories of prices; these reductions will hold 12-month inflation down until they drop out of the calculation. In June, the federal open market committee (FOMC) statement noted that it intends to carefully monitor actual and expected progress towards the symmetric inflation goal of the Fed.
Looking ahead, the FOMC expects that, with gradual adjustments in the stance of monetary policy, the economy will continue to expand at a moderate pace over the next couple of years, with the job market strengthening somewhat further and inflation rising to 2 percent. Yellen noted that the judgement reflects that monetary policy remains accommodative. The developments should also increase resource utilization somewhat further, there fostering a stronger pace of wage and price increases. However, she added that there is uncertainty about when and how much inflation will respond to tightening resource utilization.
With respect to monetary policy, the FOMC expects that the evolution of the economy will warrant gradual increases in the federal funds rate over time. Yellen elaborated that the fed funds rate remains somewhat below its neutral level – that is, the level of the fed funds rate this is neither expansionary nor contractionary and keeps the economy operating “on an even keel”. Because the neutral rate is currently quite low by historical standards, the fed funds rate would not have to rise all that much further to get to a neutral policy stance. Yellen also anticipates that the factors that are currently holding down the neutral rate will diminish somewhat over time, and therefore additional gradual rate hikes are likely to be appropriate over the next few years. The FOMC also continues to anticipate that the longer-run neutral level of the federal funds rate is likely to remain below levels that prevailed in previous decades.
Finally, Chair Yellen referred to monetary policy rules (“Taylor rules”) that the FOMC routinely consults.  She noted that “such prescriptions cannot be applied in a mechanical way; their use requires careful judgments about the choice and measurement of the inputs into these rules, as well as the implications of the many considerations these rules do not take into account (Figure 3).
In the last part, Yellen talked about balance sheet normalization. The FOMC intends to gradually reduce the Fed’s securities holdings by decreasing its reinvestment of the principal payments it receives from the securities held in the System Open Market Account (SOMA). The FOMC currently expects that, provided the economy evolves broadly as anticipated, it will likely begin to implement the balance sheet normalization program this year. The FOMC currently anticipates reducing the quantity security holdings (and, hence, the supply of reserve balances to the banking system) to a level that is appreciably below recent levels but larger than before the financial crisis. The Fed does not intend to use the balance sheet as an active tool for monetary policy in normal times. However, The FOMC would be prepared to resume reinvestments and to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.