Solid employment should continue to support consumption and the housing market; inventory restocking and government spending should also contribute to growth. Importantly, while employment gains have decelerated as the economy nears full employment, monthly payrolls gains need not match the 230,000 average of the past few years to achieve further declines in the unemployment rate. As long as non-farm payroll employment grows by at least 100,000 per month, the unemployment rate should continue to decline.
As indicated in the chart below, the size of the labor force is a major determinant of nominal GDP growth. In July, the US labor force grew by 1.4% year over year. Adjusted for the participation rate, it grew by 1.7%, which represents the second strongest rate of change in eight years.
Following on improving economic data and easier financial conditions, we believe the Federal Reserve may consider increasing rates in 2016. It may, however, take a cautious approach to rate increases, monitoring international developments and particularly the impact of Brexit on global growth, thereby reducing the possibility of sharp dollar appreciation.
Inflation May Increase
Inflation may increase over the second half of the year. CPI and core CPI rose 0.8% and 2.2% respectively, year-over-year in July, compared to 0.7% and 2.1% at year-end 2015, as the dollar has moderated, wages have increased and energy prices have recovered. Core PCE, the preferred inflation measure of the Fed, rose 1.6% year-over-year in June, and is up 1.9% year-to-date, annualized, compared to 1.4% in December, 2015.
Wage inflation, which is closely watched by the Fed, continues to grind higher. The employment cost index (ECI) has risen from 1.9% year over year in the first quarter of 2016, to 2.3% in the second quarter. Average hourly earnings (AHE) have increased steadily to the current 2.6% year over year as of July, from 2.3% in 2015 and 2.1% in 2014. Finally, the Atlanta Fed’s wage tracker indicates that median wage growth has climbed from less than 2.0% in 2012 to 3.6% over the past year.
For more detailed comments from Ken Taubes on the US economy, read his most recent Outlook.