The pieces are falling into place

By G.I. | WASHINGTON, DC

TURN off the alarms. After several weeks when the data pointed to a recovery still struggling to achieve escape velocity, the March employment report provided reassuring evidence that, at a minimum, it is still gaining altitude.

Total payrolls excluding agriculture rose a hefty 216,000, or 0.2%, the biggest monthly gain since last May. Private payrolls advanced 230,000, and by 470,000 over the last two months, the biggest such gain in five years. Government employment continued to slide.

The unemployment rate, meanwhile, edged lower, to 8.8%, its fourth straight drop. It has now fallen a full percentage point since November. That's a surprisingly fast drop, given the unimpressive pace of concurrent GDP growth of about 2% to 3% annualised. Two factors can explain the unusually rapid decline in unemployment. One is that the household survey used to calculate the unemployment rate shows much more rapid employment growth since November (1.4m) than the separate survey of establishments that yields payroll employment (630,000). Exactly why is a mystery.

The second reason for the rapid drop in unemployment is that the number of people either working or looking for work (the labour force) has not grown since November, which is a surprise: typically, you'd expect that the return of discouraged workers to the job hunt would buoy the ranks of the officially unemployed. The fact that it has not is, counterintuitively, a bad sign. March did provide a faint signal of improvement as the labour force grew 160,000. However, that's only about as fast as the working-age population grew. The participation rate, the share of the working-age population in the labour force, remained stuck at 64.2%, the lowest since 1984. Economists keep expecting participation to rebound, which is one reason they were anticipating a higher, not lower, unemployment rate. The fact that participation refuses to rise is a troubling sign.

Manufacturing employment grew for the fifth straight month, continuing the factory sector's encouraging rebound. Construction employment was flat, which isn't a surprise, and temporary employment, considered a leading indicator of permanent hiring, rose.

This report is solidly positive for the economy: bit by bit the pieces of recovery are falling into place. No doubt, it will reinforce expectations that the Federal Reserve should either call an early end to its quantitative-easing programme of bond purchases (now scheduled to end in June), or start raising interest rates soon. That indeed was the message a bevy of hawkish Fed presidents delivered in the past week.

That seems premature, for two reasons. First, other economic data is not as upbeat as employment. Recent reports on durable goods, housing and so on all suggest the economy is growing at just a 2% to 2.5% annual rate in the current quarter, well below the 3.5% to 4% rates that many forecasters were anticipating for the year as a whole. What explains the divergence? For one thing, while employers are hiring more workers, they haven't added to their hours in recent months. Total hours worked grew at only a 2% annual rate in the first quarter. Another explanation might be that productivity growth has ground to a halt, which is neither surprising, given its rather feeble performance to date, nor bad. Nonetheless, in sum the data point to an economy growing at or slightly above its potential rate, but hardly surging, which is likely to be the pattern for the next several years while deleveraging proceeds apace. If underlying demand remains stubbornly sluggish, because of higher oil prices for example, employment could peter out again, as it did a year ago.

The other reason for caution is pay. Average hourly earnings were flat last month, and are up just 1.7% from a year earlier, half the rate at which they were growing before the recession. Inflation expectations have risen a bit, but there is no sign that workers have been able to leverage their concern about higher food and petrol prices into higher wages. The surge in oil prices is eating into disposable income and being felt in consumer spending.

There may be a case for the Fed to back away from its ultra-easy monetary stance sometime this year; however, it will take many more months of good economic news like today's. The more dovish, and influential, William Dudley, president of the New York Fed, said as much today. “This is welcome and not a reason to reverse course,” he said. The economy, he noted, is performing much as the Fed expected. “We must not be overly optimistic about the growth outlook.” This recovery's serial disappointments suggest he's right.