Employment Report: Let's not panic yet

Dan North | April 02, 2022

The March employment report pretty good overall but was a bit disappointing on the top line.

The economy created 431,000 jobs, which was less than expectations of 490,000, but it was still a strong number. The prior two months were revised up by 95,000 jobs. Job gains were widespread, with leisure and hospitality once again leading the way with an increase of 112,000, the most of any single industry.

With March’s report, the economy has now recovered 92.8% of all the jobs lost during the shutdowns of March and April 2020. But there are still 1.6 million jobs to be recovered. The unemployment rate dropped from 3.8% to 3.6%, just above the pre-pandemic level of 3.5%, which was the lowest in over 50 years.

However, the unemployment rate does not take into account the 99 million people who are metaphorically “sitting at home.” Those people are classified as “not participating in the labor force.” Thus the labor force participation rate gives a better picture because it counts the percentage of the population that is participating in the labor force and driving the economy. That number rose 0.1% to 62.4%, up from the April 2020 low of 60.2%. However, it’s still 1% below the 63.4% level from before the pandemic. The drop in Covid cases is contributing to the job gains. The number of people who couldn’t look for a job because of Covid dropped from 1.2 million in February to 900,000 in March.

Wage growth has now become a critical feature in the inflation picture. And in March, wages continued their steep rise, gaining 0.4% m/m to a new (ex-Covid) record high of 5.6% y/y. However, after extraordinary consumer inflation of 7.1% y/y, those wage gains have fallen to -2.4% y/y – wage earners are losing ground. Wage data for production and non-supervisory employees goes back much further in time and shows that the current wage growth of 6.7% y/y is at a 40 year high.
wages - sept2021
But once again, inflation sends that growth to -1.2%. When consumers’ purchasing power is falling, real consumption, which provides 70% of all economic activity will fall as well. Negative real wages are a real weight on the economy.
nfibsurvey - sept2021
Before the recent spike in wages, globalization had forced U.S. employees to compete with much lower wage earners all over the world, holding down wage growth here for decades. Not anymore. The chronic shortage of labor is driving wages up. The Job Openings and Labor Turnover Survey (JOLTS) report released this week once again showed a remarkable gap between job openings and hiring. 
job openings-sept2021
The record was set a few months ago at 5 million, and although the latest figure is an improvement at 4.6 million, the long-term chart below shows it hardly matters - a 4.6 million person gap is historically gigantic. Surveys from the National Federation of Independent Business (NFIB), show record levels of participants who have either given compensation increases to their employees or who are planning to soon. 
job openings-sept2021
And as a result, those same participants are also planning to raise their product prices to compensate for the increased labor costs. Wage inflation is now contributing to overall inflation. Wage inflation has been largely absent for decades, and this has been one of the reasons overall inflation has been so tame - up to now.
job openings-sept2021
The PCE deflator set another 40-year record at a scorching 6.4% y/y. The core deflator, which strips out volatile food and energy prices rose to 5.4%, a new 39-year high. The Fed’s inflation target for the PCE core is 2%, showing just how far behind the Fed is in trying to battle inflation.
job openings-sept2021
The same report showed that real disposable personal income (DPI), which is after inflation and taxes, fell -0.16% m/m, the seventh consecutive decline, to -1.6% y/y. Incomes are declining as the effects of massive fiscal stimulus programs are wearing off. This does not bode well for future spending since the excess savings that have fueled consumption are now decreasing, and income will have to step in but it is now decreasing as well. In fact, real personal consumption expenditures fell by -0.37% m/m, the third decline in three months.
job openings-sept2021
Even more inflation appeared this week in the Case-Shiller home price index which gained 1.3% m/m in January. It was the 17th consecutive month where prices grew more than 1%. The y/y rate rose from 18.9% to 19.2%, which is a bit below the record high of 20% set last August, but again the long-term chart shows that it hardly matters – housing prices are roaring. In fact, since May of 2020, just as the economy started its recovery, housing prices have risen 30.6% but hourly wages have only risen 6.3%. Surely this situation cannot last and suggests that the housing market could be in a bubble.
All of this inflation is no doubt feeding into consumer confidence. The Conference Board’s survey asks consumers what their assessment of the current situation is and also asks about their expectations for the future. Consumers’ assessment of the current situation, the brown line in the first chart, remains strong, but their expectations, the green line, are falling rapidly. 
job openings-sept2021
When the gap between those two widens, it’s a bad sign, because when consumers are worried about the future, they are usually right. In fact, when you take the difference between the two measures, as shown in the second chart, it is a very strong signal of a recession, and right now it is a very wide gap of -76. It’s just about as good an indicator as the yield curve (more on that below).
job openings-sept2021

And that leads us to the Federal Reserve which is supposed to be fighting all that inflation. My latest note of March 17th discusses in more detail how badly the Fed needs to move but, here is a synopsis.

The Fed has created inflation by leaving emergency policy conditions of 0% rates and massive virtual money printing in place for at least a year too long. It’s the classic formula for inflation. Then the Fed insisted for most of 2021 that inflation was merely “transitory” and would go away soon. Then after they realized it wasn’t transitory at the beginning of December 2021, they still waited for four months before doing anything. In fact, they kept adding to the balance sheet up until the third week of March. And of course, it took them until March 16th to make the first interest rate hike. It’s impossible to reverse those mistakes in a snap. 

Neither the labor shortage nor the clogged supply chain is going to disappear anytime soon, so they will both be contributing to inflation for some time. 
job openings-sept2021
The Fed Funds futures markets are now projecting that the Fed may have to raise rates eight or more times this year. But there are only six meetings left this year, so that implies that at some meetings The Fed will have to hike 0.50% instead of the usual 0.25%.
job openings-sept2021

Here’s another chart that shows how far behind the Fed is based on the variables it is supposed to manage, inflation and unemployment. Each dot on the chart represents the first month of a hiking cycle. The further out to the right you go on the bottom axis the more you are ahead of unemployment, and the further down you go on the vertical axis, the further you are ahead of inflation.

Ideally, you would start hiking while you are ahead of both, which is in the lower right quadrant, such as in November 2015. Instead, the Fed is way up in the upper left quadrant showing how far it is behind both inflation and unemployment. It’s a remarkable chart.

job openings-sept2021
Finally, you have all heard me talk about the yield curve and its predictive powers ad nauseam. When it inverts (the blue line goes negative) it has historically been because the Fed raised rates too far and held them there for too long. And that gives a signal that a recession is imminent in 3-5 quarters. 
The first chart uses quarterly data, and you can see that the yield curve, the blue line, is going down but has not gone below zero yet. 
job openings-sept2021
However, if you look at the daily data, you see a more ominous picture. In fact, as of this writing on April 1st, the yield curve has actually been inverted by a teensy-tiny 0.07% or 7 basis points. But it needs to be inverted for some weeks or months to really sound the alarm.
job openings-sept2021
Some of you with sharp eyes and memories may realize I usually show the spread between the 10-year and the 3-month, not the 10-year and the 2- year shown above. 
. The 2-10 spread seems to be very popular, but the original research done on the yield curve suggests that the 3mo-10yr spread has a greater correlation with GDP, and I have found that to be the case as well.
job openings-sept2021
It usually tells the same story as the 2-10, but not now. Now the 3mo-10yr is not inverted at all, yet. But I expect it will invert, confirming the 2-10 signal.
job openings-sept2021

So let’s not panic yet. In the near term consumers still do have excess savings to spend, there is work in the pipeline with new orders and backorders near record highs, overall economic demand is strong, high-frequency indicators are all good, Covid is on the run, and the labor market is rapidly creating jobs.

We are in good shape for a while. But the Fed will likely raise the Fed Funds rate too far too fast (it has to now) which will invert the yield curve. In addition, there are some other ominous signs associated with a recession, such as a spike in oil prices, consumer fear of the future, and perhaps a housing bubble. But none of this suggests a recession this year. However, it is quite likely in 2023 – not set in stone – but quite likely.

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