It is commonly recognised that the Eurozone economic cycle is lagging that of the US by roughly three years.
Despite the clear parallels, investors appear to be heedless to the lessons learnt about the US over that time.
Notable amongst these lessons has been the proclivity for the Federal Reserve to be caught on the hop, specifically in its economic projections.
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The US economic surprises weren’t so much around headline growth; the Fed’s 2014 prediction that 2017 growth would average about 2.4 per cent looks downright prescient today.
It was elsewhere that things went awry. Indeed, a curious combination of much tighter unemployment and looser monetary policy than anticipated has prevailed – the latest unemployment rate is down to 4.1 per cent, and Fed funds rate is being held low in a range of 1.25 to 1.5 per cent.
It turned out that the US economy could operate at a significantly lower than expected rate of unemployment, somehow without delivering undue inflationary pressures.
No one really knows exactly why US wage growth has languished in the doldrums. The mystery of why a booming economy hasn’t produced fatter paychecks has given rise to a whole host of theories.
Two of the most plausible explanations are that there is “hidden unemployment” not captured in the headline rate, and that older workers, on lower average pay growth, are staying in employment for longer and depressing aggregate pay growth.
These factors are likely to play an even greater role in muddying the relationship between European unemployment and wage growth. The headline rate of unemployment could grind to a very low level by historical standards with very little upward pressure on wages.
Much as there were in the US, in Europe there are signs that a relatively high proportion of workers with jobs would like to be working more hours. But the most interesting component of the story is the people on the fringes of the labour market being enticed back into gainful employment.
The participation rate in many European countries is currently still extremely low.
In France, roughly 56 per cent of adults participate in the jobs market in some way, compared to 63 per cent in the US. Germany has a rate higher than its continental neighbours (61 per cent), but still well below the US. In Italy, the participation rate is less than 50 per cent.
The difference is most stark in the older age categories. In the US, nearly 20 per cent of over-65 year olds work, compared with seven, three, and four per cent in Germany, France, and Italy respectively.
But a pressure to join the labour force is mounting, from all directions, for all age groups. Bloated government balance sheets and a push for social reform are contributing to incrementally siphoning what were once generous benefits. One example is public and private early retirement schemes, which are being phased out.
The conventional view – that Europe has poor demographics – misses this untapped potential workforce entirely.
The key lesson is that the headline rate of unemployment is profoundly misleading.
This traditional indicator is a poor gauge of limits to growth or incipient inflationary pressures – and this will be even more of an issue for Europe than it has been for the US.
European firms are likely to be able to bear down on wage pressures for some time. If robust global demand means they regain some top line pricing power, then the scene is set for an expansion in corporate margins.
Meanwhile, the ECB is likely to be troubled by wage growth that remains too low to be consistent with their close-to-but-below two per cent inflation target. They are likely to fret over the possibility that inflation has got stuck or de-anchored.
While they may still feel it appropriate to cease adding to their balance sheet over the course of 2018, the prospect of normalising interest rates shortly after seems remote.
The lessons of the US economic cycle are writ large for Europe; robust growth, low cost pressure, and loose monetary conditions could well fuel risk assets, for far longer than one might imagine.