Labor Day is now in the books, marking an unofficial end to summer. The day was set up to pay tribute to the contributions and achievements of American workers and became a federal holiday in 1894. The labor market has changed significantly over the years and the ways we measure the market have multiplied with the advent of new tools and data that parse out details that are closely analyzed by a host of constituents- not the least of which is the Federal Reserve.
According to the Federal Reserve website, “The Federal Reserve Act mandates that the Federal Reserve conduct monetary policy “so as to effectively promote the goals of maximum employment, stable prices, and moderate long-term interest rates.” Even though the act lists three distinct goals of monetary policy, the Fed’s mandate for monetary policy is commonly known as the dual mandate. The reason is that an economy in which people who want to work either have a job or are likely to find one fairly quickly and in which the price level (meaning a broad measure of the price of goods and services purchased by consumers) is stable creates the conditions needed for interest rates to settle at moderate levels.
“To assess the maximum-employment level that can be sustained, the FOMC considers a broad range of labor market indicators, including how many workers are unemployed, underemployed, or discouraged and have stopped looking for a job. The Fed also looks at how hard or easy it is for people to find jobs and for employers to find qualified workers. The Federal Open Market Committee, FOMC, does not specify a fixed goal for employment because the maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market; these factors may change over time and may not be directly measurable. However, Fed policymakers release their estimates of the unemployment rate that they expect will prevail once the economy has recovered from past shocks and if it is not hit by new shocks.”
Last Friday, we got yet another reading on the labor market. What is the potential impact on the Fed and ultimately how it may affect the Fed’s rate hike voracity and timing?
The Labor department reported that the economy added 315k jobs in August, slightly ahead of consensus expectations for a 296k gain. The unemployment rate rose to 3.7%, above the 3.5% estimate. The labor force participation rate in August also registered a notable uptick, to 62.4% from 62.1% the prior month, matching the highest level since March 2020.
Prior estimates of job growth for June and July were revised down and the overall level of job growth indicated a slowdown from July. The modest slowdown in hiring following July’s blockbuster pace corroborates anecdotal evidence suggesting that companies are starting to turn cautious amid waning economic growth. Job offers are being rescinded and news of layoffs now begin to permeate. Earlier last week, ADP’s private payrolls report said that payrolls added 132,000 positions in August, well below the 225,000 estimated.
Oxford Economics notes that despite a significant downward revision to the June payroll gain, employment was still 240k above its pre-pandemic level last month, though the jobs recovery has been quite uneven. The leisure and hospitality sector remains short of 1.2 million jobs while the government sector is still missing 645k jobs. At the same time, employment in professional and business services and transportation are well above their February 2020 level.
Chairman Powell suggested “some softening” of labor market conditions would likely be required to bring down inflation towards the Fed’s goal of 2% (a goal some now question as lofty). Last week’s report could be seen as an indication of some softening but still strong enough to allow the Fed to implement their telegraphed hikes without pushing the economy into recession (a soft landing). The increase in participation rate is important because a sustained slowing wage growth will require further participation.
Unfortunately, as noted above, the Fed is partly focused on the ability of employers to find qualified workers. The mismatch is problematic. In April 2022, Stanley Black & Decker ( NYSE: SWK) released the results of its inaugural Makers Index, an in-depth research study examining sentiment about skilled trade careers in the United States, specifically among young people and their parents, with the goal of better understanding some of the underlying causes of the skilled trade labor shortage. The data suggested that young people are not seriously considering the trades. Stanley Black & Decker, Inc., CEO Jim Loree opined that “The skilled labor shortage is one of the biggest challenges facing the U.S. economy, with 650,000 open jobs in the construction industry alone.” The report goes on to suggest ways to address this challenge and is worth a quick read.
Labor markets are just one of the focuses of the Fed but certainly an important one. Friday’s report likely had elements that the Fed will like, some that they do not like, and some that will need more data to confirm any trends. Seasonal factors can also distort some of the recent data making any interpretation difficult. Overall, the labor market’s relative strength is what will seemingly allow the Fed to stay on their telegraphed course. The plus side of wage growth shows up in consumer confidence numbers that rose the most since May and indicate that spending may continue, helping to support earnings-a key factor in market direction over time.
What seems clear is that wage growth in the 5-6% range is not consistent with a 2% inflation target without a commensurate increase in productivity (highly unlikely given that Nonfarm business labor productivity decreased 4.1% in Q2 2022 per the U.S. Bureau of Labor Statistics). Perhaps the declines in savings, stocks and bonds, and home prices will push more workers into the work force and provide some downward pressure on wages. Markets still expect a 75-basis point hike later this month, but the recent labor data has opened the door for 50 basis points. Ultimately, the inflation data (we will see next week) are the key to the Fed’s decision. For now, the market is digesting the Fed’s most recent no-nonsense comments that they are prepared to see the economy endure “pain” as a side effect of battling inflation. The Fed is clearly not afraid to push the envelope even at the risk of recession. The result has been a retracement of some of the recent summer gains. Like many indicators of late, good news on the economy can feel like bad news for the markets and vice versa- all data that the Fed will process in their decision. As the data rolls in, we expect the volatility to continue.
Past performance shown is not indicative of future results, which could differ substantially.
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