The Big Picture

Briefing.com Summary:

*The labor market looks healthy on the surface, but worker purchasing power is deteriorating.

*Consumers have limited and increasingly unattractive options to offset lost purchasing power.

*The economy is still growing above trend, but persistent declines in real earnings could become a future growth risk.

A lot of pundits were singing the praises of the May employment report. We can see why that was the case. Nonfarm payroll growth was much stronger than expected and accompanied by upward revisions for March and April; the civilian noninstitutional population employed increased by 149,000; and the unemployment rate remained at 4.3%, which is just about full employment in the eyes of the Federal Reserve.

What we saw, though, and what many seemingly chose to ignore, was less praiseworthy and potentially quite concerning for the growth outlook.

To be sure, as much as we would like to sing the praises of this headline-beating report, someone also needs to keep it real.

Purchasing Power Fading

To put it bluntly, workers aren't earning as much as they used to, not after inflation anyway. In fact, real average hourly earnings have been negative the last two months.

In May, average hourly earnings were up 3.4% year-over-year, but when adjusted for inflation, they were down 0.4%. That doesn't sound like much, but it makes a big difference for a consumer-driven economy if purchasing power is lost in the face of higher costs.

Trade-Offs

When consumers face a decline in purchasing power, they have several choices to make:

• They can spend less, with a focus toward spending on necessities and not discretionary goods/services.
• They can forego premium brands in favor of generic products.
• They can tap into personal savings to maintain their spending.
• They can increase their borrowing (think credit cards, personal loans, home equity, buy-now-pay-later) to cover their needs and/or wants.
• They can save less (if they were in a position to save money with which to begin).
• They can seek additional sources of income by taking on extra work or a second job.

The trade-offs here aren't enticing.

If consumers spend less, the economy will be challenged to exceed its potential growth rate (~2.0%). That would presumably help ease some of the inflation eroding their purchasing power, but the adverse trade-off is that it could lead to higher rates of unemployment that, in turn, erode/destroy purchasing power by taking away income.

Tapping into savings to keep spending might be a placating option for the consumer and the economy, but it leaves one at risk of not having enough money to cover an emergency expense such as a medical bill, a new HVAC unit, or a car repair, which could then force one to take on debt to cover those expenses.

The latest data from the BEA doesn't paint a pretty picture of personal savings. At 2.6%, the personal savings rate as a percentage of disposable income is close to a 30-year low.

Taking on debt to maintain spending isn't a great or recommended solution in most cases either, especially in an environment of high interest rates. With the increased debt comes an increased burden to service the debt, which poses an added problem if real earnings are declining or a person loses their job.

Earning additional money from working more or taking a second job is a commendable undertaking, yet it could invite health risks, from less sleep to more stress, and/or quality of life issues that adversely affect personal relationships.

Given this, one can see the importance of getting inflation under control before the consumer forces an inflection point for an economy that has seen an average 2.6% real GDP growth rate over the past four quarters.

The Atlanta Fed GDPNow model estimate for real GDP in the second quarter stands at 3.0%. It had been 3.7% at the start of the forecast period. To be fair, 3.0% is well above the economy's growth potential, so despite the worsening trend in real earnings, the economy is not flirting at all with a recession.

That may not be the case, though, if this worsening trend persists and threatens the stock market's very rosy earnings growth outlook.

This is not a forecast. It is a warning, which we also discussed in this column roughly a month ago.

Briefing.com Analyst Insight

There was reason to cheer the May employment report. It is a good thing to see more people employed. We should be cheering that.

The wrinkle in that is that they are not being paid as much as before. Forget about inflation. That is true on a nominal basis, as the chart below shows, suggesting one of two things: 1) Employers are tightening their budgets, or 2) there is some dynamic hiring activity but in lower-paying jobs.

The strongest hiring activity in May was in the leisure and hospitality industry (70,000). The information (-2,000) and financial (-22,000) industries saw declines in employment levels.

The 172,000 increase in nonfarm payrolls in May makes it clear that there were jobs to be had, but we also spied a jump in the percentage of workers unemployed for 27 weeks or more to 27.5% from 25.3% in April and 20.4% a year ago. Our thinking is that this speaks to some difficulty in finding a new job with comparable compensation to the one that was lost.

Those points got lost in the excitement over the headline nonfarm payrolls number. That was real, but if keeping it real, one cannot dismiss the decline in real earnings. That isn't mattering as much now, but it will later if it persists.

--Patrick J. O'Hare, Briefing.com