Focus

January 20, 2023 | 12:49

Why Is Employment Still So Strong?

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Econom... (Read more)

Michael Gregory , CFA

Deputy Chief Economist, Head of U.S. Economics and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Benjamin Reitzes

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal for over a decade. He is responsible for the Canadian macro-economic... (Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

(Read more)

Art Woo

Senior Economist and Director
Economics

Art joined the Bank of Montreal in 2014. His primary responsibility is analyzing global economic, financial and ... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Econom... (Read more)

Michael Gregory , CFA

Deputy Chief Economist, Head of U.S. Economics and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Benjamin Reitzes

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal for over a decade. He is responsible for the Canadian macro-economic... (Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

(Read more)

Art Woo

Senior Economist and Director
Economics

Art joined the Bank of Montreal in 2014. His primary responsibility is analyzing global economic, financial and ... (Read more)

Feature

Why Is Employment Still So Strong?

Although job growth has slowed from the rapid reopening pace, it remains much stronger than usual. U.S. nonfarm payrolls grew an average of 247,000 per month last quarter, still 30% above the decade norm before the pandemic (Chart 1). Canadian employment even sped up at year-end after shrinking last summer. What makes this buoyancy odd is that the economy appears to be slowing and businesses expect it to contract. This article tries to explain the puzzle and asks whether it reveals anything about the odds, timing and severity of a downturn.

Businesses have been eager to hire likely because they are still trying to catch up with demand. While employment surpassed pre-pandemic levels in late 2021 in Canada and last summer in the U.S., it still falls short of levels that would have been reached had it kept growing at prior rates. The estimated ‘jobs gap’ is nearly 4% in the U.S. (Chart 2) and under 1% in Canada. Much of it reflects the millions of retirees who are still spending but not working.

A second reason for robust hiring is that companies suspect the downturn will be shallow, a view shared by most economists. The Bank of Canada’s business survey notes, “While most firms expect Canada to be in a recession within the next 12 months, the majority of those firms think it will be mild”. In this event, hoarding or even adding staff likely makes sense to avoid scrambling for workers when the economy resumes growing. This mindset is ingrained given that openings have been so hard to fill for a while. To wit, the Fed’s Beige Book says “Many firms hesitated to lay off employees even as demand for their goods and services slowed”. We expect the jobless rate to peak at around 5% in the U.S. and 6½% in Canada, levels that are still below three-decade means (5.7% and 7.6%) and peaks (6.3% and 8.1%) reached in the mild 2001 slump (Chart 3). So, filling positions could still be challenging after the storm passes.

In addition, firms appear to be adding staff simply to cover illnesses. On average, 1.5 million American workers were off sick each month in the second half of 2022 (0.9% of total), compared with 1 million in the three years before the pandemic (Chart 4). This, along with a jump in part-time positions, helps explain the recent decline in U.S. work hours. Canada also experienced record rates of worker illness in 2022.

Can the current durability in labour markets inform about the odds, timing and severity of an expected downturn? To help answer this question, we looked at U.S. labour activity in the three months prior to the eleven recessions in the postwar period, apart from the abrupt pandemic-led one (Table 1). The upshot is that labour demand usually slows before the onset of recession. Household survey jobs even fell before nearly half of the downturns. One caveat is that none of the figures in the table are statistically significant at conventional levels, so the results do need to be taken with caution. Still, job growth appears to moderate toward the end of a business cycle, as one would expect when companies sense trouble and workers become harder to find.

The historical pattern of labour market weakness before a recession makes the current situation unusual for the reasons discussed above. In the U.S., payrolls have risen 0.16% on average in the past three months, just above the seven-decade mean. However, household survey jobs and work hours are weaker than usual, suggesting a softer underbelly than indicated by payrolls. In Canada, the household survey shows above-normal growth in jobs and work hours in the three months to December, while the less-timely establishment report shows sturdy job growth to October though soft work hours. Barring downward revisions to the data, job markets appear to be doing better than is historically the case before a downturn. And we haven't even considered the massive number of job openings.

The stamina in labour markets suggests three things about a looming recession. First, it might occur later than anticipated. We currently expect the downturn to begin early this year, but it could be delayed for several quarters as the full weight of past monetary actions are felt. Second, its severity could be tempered if companies continue to hang onto staff, supporting wages, confidence, and spending. And third, it could be averted entirely, though likely only if inflation falls more quickly and leads to more accommodative financial conditions. We peg the odds of a soft landing at almost 1 in 3.

Bottom Line: Trying to catch up with elevated demand while facing worker shortages and illnesses, U.S. and Canadian businesses continue to hire in large numbers, raising hopes the recession will be averted or at least be mild. A less sanguine view, however, is that the buoyant labour market might only postpone the downturn, adding stickiness to wage and price growth and more rate hikes to an already aggressive tightening cycle—a situation that would likely not end well.