Viewpoint
January 05, 2024 | 15:34
January 5, 2024
Economics
Economics
Economics
Economics
A Stellar Jobs Report—Labor Market Slowdown Ahead |
| While only the first week in January with some still shaking off their New Year’s hangovers, the labor market momentum in December, visible in the jobs report Friday, will not ease growing concerns of a deterioration in the economy in the opening weeks of the year. The employment report revealed that broad-based job growth continued throughout the fourth quarter of 2023 with gains improving to 216k to close out the year—average job gains in the fourth quarter came in at a still-healthy 165k a month. The unemployment rate finished out the year at a still historically low 3.7%, just a touch above where it ended 2022, and average hourly earnings growth over the past year remains above 4.0%—not much different from where it was in January of 2023. Between December 2022 and December 2023, the U.S. economy created another 2.697 million net new jobs. Not too shabby a performance given the most aggressive monetary policy tightening cycle since the 1980s, a spring banking crisis, a shrinking money supply, and a highly inverted yield curve with high probabilities of recession in the mix. |
| Looking ahead to 2024, last year’s labor market performance is not due for an encore and is not forecast to be repeated. We are at the tail-end of a Great Rebalancing of aggregate supply and demand. Highly restrictive monetary policy from the Federal Reserve is starting to take effect and will become more visible for the labor market and economic activity as the year progresses. Outsized government spending growth at the federal and state levels will be less of a support, while downside risks abound for the global economy due to escalating geopolitical conflicts, past global monetary policy tightening, and the potential for further supply chain disruptions. We expect monthly nonfarm payroll job growth to slow below 100k a month in the first quarter of 2024 and for the U.S. economy to add only 1.3 million net new jobs between Q4 2023 and Q4 2024 (less than half of this year’s pace). There are a few early signs of the coming labor market slowdown found buried deep in Friday’s December jobs report. We would point to: persistent monthly declines in temporary positions that show a softening demand for labor; the large drop in household employment, which often leads declines in nonfarm payrolls at turning points in the labor market cycle; and the large increase in the average duration of unemployment to 22.3 weeks in December, the longest since August 2022. The latter shows it is getting tougher to find a new job. The December ISM Services index also provides a clear warning on the first quarter’s labor market performance. Not only did the headline composite index slump to a near-stagnant 50.6 from 52.7 in November, but the service sector Employment Index plunged deeply into contraction territory to 43.3 from 50.7 in November. This is the lowest reading on the employment component since July 2020 and could be seen by some as a potential recessionary signal. Like the Fed, we await further data and confirmation from other economic indicators that services activity and hiring are as weak as this shockingly low number on this index suggests. It certainly isn’t visible in the December employment report, or the low weekly initial jobless claims data. While the market does put some weight on this ISM indicator, it is still just a survey number and not a hard economic or labor market indicator, and only one month of data does not make a trend. |
Fed’s Still ‘Higher-for-Longer’ |
| Financial markets were itching for hints of a policy pivot heading into the FOMC’s announcement on December 13; and they thought they found them, particularly in the dot plot and Chair Powell’s bon mots. Another rate hike in 2023 (as projected three months earlier) was, of course, not realized. One word was inserted into the Statement’s forward guidance (“In determining the extent of any additional policy firming…”) to signal the Committee now judged further rate hikes as “not likely”. And another quarter-point rate cut appeared in 2024, on top of the 50 bps already there. The new signs of ‘no more hikes’ and ‘even more cuts’ smacked of an approaching policy pivot in the markets’ minds. Then, in the presser, Chair Powell acknowledged the Committee discussed “the question of when will it become appropriate to begin dialing back the amount of policy restraint in place”. That was all markets had to hear, drowning out the ‘higher-for-longer’ refrain that still permeated some of Powell’s other remarks. The odds of a rate cut as early as March jumped from 7% the day before to 79% at the close and eventually becoming completely priced in by Boxing Day (aided by a benign PCE prices report). After some sober second thought and ahead of this week’s major data releases, the dovish conviction faded a bit. The Minutes from last month’s Fed confab (which were more hawkish than the market expected) and December’s employment report (sturdier) suggest it was correct to curb enthusiasm… and we reckon more curbing is called for. The market odds of a March move are currently 66% with the dial fully turned back a notch by May and another four times by December. Despite recently giddy markets, rate cuts in 2024 have been on the Fed’s policy table for a while now. For example, since the FOMC first revealed a 5%-plus ending level for 2023 almost 13 months ago, rate reductions for this year have run in the range of 50 bps to 100 bps. For the latest 75 bp call, the Minutes showed no indication at all whether rate cuts were close at hand or whether some semblance of a timetable was being crafted, thus cooling the ‘early easing’ speculation. In discussing their projected rate reductions (with 17 of 19 participants penciling in at least one, and 11 forecasting at least three), policymakers noted the “unusually elevated degree of uncertainty” surrounding their outlooks and that “it was possible that the economy could evolve in a manner that would make further increases in the target range appropriate”. Although more rate hikes were no longer considered probable, they weren’t being taken “off the table” (Powell). Several participants also noted “circumstances might warrant keeping the target range at its current value for longer than they currently anticipated”. These comments don’t read like a committee poised or planning to ease anytime soon. Elsewhere in the Minutes, “many participants remarked that an easing in financial conditions beyond what is appropriate could make it more difficult for the Committee to reach its inflation goal”. Depending on the growth, inflation, and labour market backdrop, this poses a potential situation in which the more markets rally in anticipation of early or aggressive easing, the more likely the Fed is going to ease only gradually, if at all. This harkens back to Powell’s presser comment: “… it’s important that financial conditions become aligned or are aligned with what we’re trying to accomplish, and, in the long run, they will be, of course, because we will do what it takes to get to our goals. And, ultimately, that will mean that financial conditions will, will come along. But in the meantime, there can be back-and-forth…”. The Minutes corroborated what Powell also mentioned in the presser, that there has been meaningful progress in moderating growth, slowing inflation, and balancing the labor market—enough progress to make more rate hikes unlikely. However, Powell said: “We still have a ways to go. No one is declaring victory. That would be premature. And we can’t be guaranteed of this progress [continuing].” And it’s this road still to go and the uncertainty surrounding it that’s keeping rate hikes on the table and the easing schedule indistinct despite rate cuts also being on the table. The Fed is biding time, as it appears to be achieving the elusive ‘soft landing’. Policy has tightened enough, to dampen demand enough, to result in meaningful disinflation without a broad economic downturn or major deterioration in the labor market—strongly aided by the remedy of previously snarled supply chains. But the latter is now no longer magnifying the soft landing’s disinflationary trends, suggesting the ‘last mile’ to price stability could be more stubborn in the absence of even more dampened demand. Yet, demand is doing better than expected; the Atlanta Fed’s latest GDP Nowcast for Q4 is 2.5% (as of January 3rd, before the employment and ISM Services reports), more than double what we’ve been forecasting (1.0%). However, the slip in December’s ISM Services PMI to barely above the 50 mark and net dip in aggregate hours point to a Nowcast downgrade. Meanwhile, global supply bottlenecks are reappearing at the Suez and Panama canals (owing to terrorism and water flow, respectively). In the Minutes, participants discussed the risks to the outlook, with offsetting ones on the growth side but only upside ones on the inflation side. The latter included “possible effects on global energy and food prices of geopolitical developments, a potential rebound in core goods prices following the period of supply chain improvements, or the effects of nearshoring and onshoring activities on labor demand and inflation”. A litmus test for both growth and inflation risks along with last-mile stubbornness will be the labor market. The better balance the Fed is trying to achieve continues to unfold without job losses as fewer job openings (by 62,000 in November or 2.4 million year-to-date) have flattened labor demand amid an expanding labor supply, resulting in slower wage growth. However, December’s employment report was sturdy, with payrolls expanding a decent 216,000 and the jobless rate stable at 3.7% (as both household employment and the labor force dropped a hefty 0.4%). Average hourly earnings grew 0.44% (vs. 0.35% in November), lifting the annual change a tenth to 4.1% y/y (see Scott Anderson’s piece for more details on the employment report). With FOMC participants emphasizing “the importance of maintaining a careful and data-dependent approach to making monetary policy decisions”, the employment report points to more time needing to be bided. Finally, the Minutes “reaffirmed that it would be appropriate for policy to remain at a restrictive stance for some time until inflation was clearly moving down sustainably toward the Committee’s objective”. Yes, rate cuts are on the table, but the Fed is prepared to allow them to collect some dust first. |
