A Word on Employee Earnings Growth ahead of the January Nonfarm Payroll Report

Perhaps the most important feature in the January employment situation report is the wages component. Average hourly earnings (AHE) accelerated to 2.9% y/y in December, the highest since June 2009 when the economy was coming out of recession (the jobs recession did not end until February 2010). December's AHE gain owed heavily to a 10-cent (0.4%) increase over the prior month's earnings, though that followed a two-cent (0.1%) decline in November. Taken as a 3-month average, AHE rose six cents (+0.2%) in the fourth quarter, the same gain as in the quarter before that, and the quarter before that.

With an estimate of +0.5% m/m, J.P. Morgan provided the highest forecast for the January change in AHE, and that should matter because J.P Morgan economists are the top forecasters for average hourly earnings over the previous 12 months according to Reuters polling data. But JPM economists seem to be borrowing heavily from the seasonal pattern observed over the last two Januaries. In January 2015, AHE rose 15 cents (+0.6%) and in January 2016, AHE increased 12 cents (+0.5%). Both followed AHE decreases in December, however, whereas AHE had already risen 10 cents (+0.4%) in December 2016.

The average change between December 2014 and January 2015 was four cents (+0.2%), while the average change between December 2015 and January 2016 was five cents (+0.2%). If January 2017 AHE were to rise 0.5%, the average increase over the latest two months would be 11 cents (+0.4%). It is possible, but we think unlikely.

AHE could rise 12, 13 or 14 cents and leave the m/m change at +0.5%. A 12-cent rise would leave the year-on-year change at 2.9%, unchanged from December, while a 13- or 14-cent rise would push AHE up to a 3.0% y/y gain, the biggest since April 2009 (3.4%) and certain to capture the Fed's attention.

Part of the reason the last two Januaries had above-average AHE increases is the timing of the payroll survey itself. Empirical analysis has shown employment surveys in which the 12th of the month occurs in the first half of the week show higher AHE gains than do surveys where the 12th is in the second half of the week. January 12 in both 2015 and 2016 was a Tuesday, whereas January 12, 2017 fell on a Thursday. Of the last seven times the 12th was on a Thursday, AHE rose an average 0.2% (min +0.1%, max +0.3%).

Only one of the top 10 forecasters for AHE (Morgan Stanley) calls for a January gain of 0.2%, while two others (Daiwa Europe and ING Bank) are among the top 20 forecasters. Nevertheless, we think the smart money is on a January AHE print of 0.3% m/m or less.That would lower the year-on-year AHE change to 2.8% or below.

Average weekly earnings (AWE) are a function of hourly earnings and hours worked in the week. Workweek hours were 34.3 in both November and December, down from 34.4 in both September and October. Assuming the best-case scenario of a 14-cent (+0.5%) rise in AHE and a 0.1-hour extension to the workweek, AWE would rise $7.42 (+0.8%) on the month. That would put year-on-year growth in AWE at 2.4%, up from 2.3% in December but still below the 2.5% increase in October. The average reading in all of 2016 was 2.2%. By contrast, and not necessarily the worst-case scenario, if AHE were to rise only four cents (+0.2%) and the workweek were to be unchanged at 34.3 hours, AWE would rise $3.98, slowing the year-ago increase to 2.0%.

Overall we are positive on wage growth and we think wage pressures will start forcing the Fed's hand on interest rate increases. We do not think January, however, will provide sufficient evidence of runaway wages that require a monetary policy response in March.

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