Paying Attention to the (Less Tight) Labor Market

The U.S. Economy Is Not in Recession 

The Q2 preliminary U.S. GDP report flashed -0.9% sequential growth. And while two quarters of back-to-back GDP contraction is a recession indicator, the reason it doesn’t feel like a recession has a lot to do with the tight labor market. During historical recessionary periods, the economy experiences widespread layoffs and significant economic slowdown. And while the economy is clearly slowing, its slowing from extremely elevated levels of demand, created by fiscal stimulus from the pandemic and years of easy monetary policy. While monetary policy played an important role getting the U.S. economy out of recession in 2020, it continued for too long and contributed to the high inflation environment that we experience today. 

The Fed has pivoted to tightening monetary policy, having raised rates a cumulative 225 bps since March. The Fed Funds Rate (FFR) is now back to pre-pandemic levels and today stands at 2.25-2.50%, near what’s considered neutral. Fed Chair Powell has indicated he would like to see the Fed Funds Rate to be 3-3.5% by the end of the year. Chair Powell has recently said that “it likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation.” While many economists and investors viewed this as a “pivot” to be less hawkish, we believe inflation will remain elevated and the Fed will likely have to raise rates that are larger than expected into the end of the year. It’s noteworthy to point out that today’s comments from James Bullard, the St. Louis Fed President, believes the Fed Funds Rate should be 3.75-4.00% by the end of the year. While that may be needed, we also believe the Fed will watch the economic data, especially any of the important inflation indicators – CPI, PPI, Core PCE and Employment Cost Index. 

The Labor Market Trends: Lower Job Openings, Rising Initial Claims 

Housing was one of the first economic indicators that signaled a slowdown in demand from rising rates. This week, the ISM Manufacturing report from July indicated a slowdown, yet remains in expansion territory. The Prices Paid Index within the report fell 18 points and is now at levels last seen in August 2020. ISM Services also showed expansion with New Orders at 59.9 – clearly a signal of strength and something we’ve pointed out within the GDP report of services momentum. It too showed prices fell 7.8 points to levels last seen in February 2021. We’re now watching the labor market closely as it reverses from historically tight conditions. The July nonfarm payrolls report is released Friday, August 5^th and will provide unemployment and wage growth information. 

Chart 1: New Home Sales and ISM Manufacturing New Orders Below Historic Averages¹ 

Chart 2: Earnings Growth and Unemployment Rate Remain Better than Historic Averages² 

Job openings peaked in March at levels that represented 1.8 open jobs per available worker.³ Job openings were 10.7 million in June, down 1.2 million from the March peak, but still 50% higher than pre-pandemic levels. Similarly, initial unemployment claims have ticked up 54% since March lows but are just 6% above July 2019 levels. 

Rising initial claims have come from specific pockets of the economy, most specifically growth tech, where demand was inflated by pandemic-era stimulus. According to a Bloomberg report on Monday, the software giant Oracle (ORCL) has begun laying off U.S. workers in its customer experience business. Additionally, fintech company Robinhood (HOOD), announced in their earnings that they would reduce headcount by approximately 23%. A deeper dive into Tuesday’s JOLTS report showed the retail trade industry reducing job openings, reflecting slower consumer demand for goods, particularly housing-related. 

Chart 3: Initial Claims and Job Openings Reversing Trend⁴ 

During the Fed’s FOMC press conference last week, Powell stated “we’ve seen the beginnings of a slight lessening of the tight labor market.” Should the Fed continue their policy fight against inflation, we expect this trend in certain labor markets to continue.  

In June, wages were up 5.1% y/y, reflecting the tight labor conditions and company efforts to attract workers. Companies like Union Pacific (UNP) that can’t hire enough labor to handle demand say they’ll benefit from some demand softening. The same can be said for many areas of the semiconductor industry and manufacturers like Raytheon Technologies (RTX) and Cummins (CMI). 

Targeting a Soft Landing and Remaining at Healthy Levels of Normalization 

The key risks are that either inflation persists or the Fed goes too far and tightens too much. Either case can destroy demand and remove jobs instead of job openings, becoming more reflective of a true recession. The optimal scenario is one we hope we are in now, where the economy normalizes and inflation begins to slow – but the Fed requires more persuasive evidence of inflation meaningfully slowing before they will stop tightening. 

Inflation has proven persistent and with the Fed’s preferred measure, Core PCE, +4.8% y/y in June well-above their 2% target, they will continue to raise rates. But the Fed also recognizes that economic implications lag policy changes. The impact of QE, for example, continues to flow through in the form of company investments, municipal projects and consumers spending down elevated savings. The same will be true for the Fed’s rate hikes and balance sheet actions. Like the Fed, we are focused on the incoming data. 

Chart 4: Core PCE and Fed Funds Target Rate⁵ 

Tight Fed policy is placing the economy into low gear: softening demand, loosening the labor market and giving supply an opportunity to catch-up. The Fed continues to attempt a soft landing, where inflation nears their 2% target and the economy remains healthy. The window for a soft landing begins to shrink as the Fed becomes more aggressive and labor and demand trends accelerate. Currently, the economy is normalizing from unsustainable levels, and only time will determine where we end up. 

Stephanie Link: CNBC TV Schedule 

Sources

1. FactSet (chart)
2. FactSet (chart)
3. CNBC
4. FactSet (chart)
5. FactSet (chart)

Disclosures

Investment Solutions at Hightower Advisors is a team of investment professionals registered with Hightower Securities, LLC, member FINRA/SIPC, & Hightower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through Hightower Securities, LLC and advisory services are offered through Hightower Advisors, LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources; as such, neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Hightower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of Hightower Advisors, LLC or any of its affiliates.