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Tuesday, February 7, 2023

Confusion reigns: Strong jobs report amid recession talk

At 8:30 Friday morning, the federal government released its monthly employment report.  It showed that nonfarm payrolls added 372,000 jobs in June, which was higher than many economists expected.  The Dow Jones estimate predicted 250,000.

One reason folks were looking at this closely is that a lot of people are predicting a recession. Some believe we are already there.

Shortly after the release, Christian Lundblad, director of research at the Kenan Institute of Private Enterprise at UNC Chapel Hill and Richard Levin Distinguished Professor of Finance at UNC’s Kenan-Flagler Business School, did a press briefing.

Christian Lundblad

He reinforced what I have been thinking, which is that things are confusing. We keep hearing about a recession, and companies are hiring.

If we are going to get a real recession — what economists consider a recession — it will more likely arrive in early to mid-2023, according to Lundblad, if inflation continues to be high, requiring the Federal Reserve to keep raising interest rates.

Friday’s jobs numbers “are a license now” for a three-quarters of a percent interest rate hike — 75 basis points – at the Fed’s July 26-27 meeting, Lundblad said.  This would be on top of a three-quarter hike in June.

In May, inflation was running at 8.6%, year over year, and the June report is expected to be 8.8% when it comes out Wednesday morning, which will keep pressure on the Fed to keep its foot on the brake by hiking interest rates. When interest rates go up and the Fed takes other steps to tighten credit, it gets more expensive for businesses and households to borrow, which dampens economic activity.

The Federal Reserve — our central bank — has two goals: Full employment and stable prices. We have gone beyond full employment as the Fed defines it — meaning maximum employment without excessive inflation.  And price stability has gotten away from the Fed over the past year – after being low for a couple of decades thanks in part to efficient global supply chains that the pandemic and geopolitics have scrambled. So, the Fed is playing catchup, scrambling to get back down to its target inflation rate of 2%. The problem is that no one knows how heavy a lift that will be and how many people will lose their jobs.

Ideally, the Fed will engineer a soft landing, bringing inflation down without cratering the economy. But it may be too late for Fed Chairman Jerome Powell to pull that off. He may have waited too long. Old-timers like me recall with trepidation the late Fed Chairman Paul Volcker’s solution for double-digit inflation in the early ‘80s, which was to jack up the federal funds rate to around 20%. It worked, but the 1981-82 recession was very painful. During the Volcker war on inflation, mortgage rates topped 18% and unemployment reached nearly 11%.

Maybe the Fed can catch a break from a resolution of COVID-induced supply chain problems and energy and food spikes triggered by the war in Ukraine and wind up with a Goldilocks economy next year, with modest, recession-avoiding growth and lower inflation. We can hope.

Right now, we are probably in what Lundblad calls a “technical recession,” two consecutive quarters of shrinking gross domestic product. This is what most people think of as a recession. Real GDP dropped an annual rate of 1.6% in the January-March first quarter. And in the April-June second quarter, GDP also probably shrunk, maybe by 1.2% annualized, according to the GDPNow model used by the Federal Reserve Bank of Atlanta.

But this “rule of thumb” recession is not what the official arbiter, the National Bureau of Economic Research, uses to decide when recessions begin and end, Lundblad noted.

“Those folks look more broadly, more holistically, at the market, and a key ingredient there is the state of the labor market,” said Lundblad.

What we had Friday morning was economic cognitive dissonance — talk of a recession while the jobs report surprised on the upside.

“So just squaring that all in our minds is a little bit the challenge of our time today,” he said. The headline unemployment rate — 3.6%  — is “essentially at a 50-year low.” An alternative measure, the so-called U-6 rate, which takes in part-time, underemployed workers who would like full-time employment, is also a record low 6.7%.

“We’ve essentially ground our way back to where we were pre-COVID. Overall, employment is a little below where we were,” said Lundblad. According to the Bureau of Labor Statistics, the private sector has 140,000 more workers than in February 2020, while the government workforce is 664,000 less.

One problematic statistic is the drop in labor market participation, how many folks are either in the workforce or looking for jobs. The number of Americans in the labor force dropped by 353,000 from May to June. Now, in a labor force of more than 164 million workers, that’s not a huge number, but in an already tight labor market, it’s not great.

“It is suggestive of something important here, which is what’s driving that motivation here,” said Lundblad. “What we would like to see is Americans kind of moving back into the labor force, maybe taking some of the pressure off of the labor market and the wage pressures that we’ve been seeing.

“And that gives the Fed a little ability to perhaps step back from some of the challenges that they’ve been facing on wage and price pressures.”

Over the past 12 months, average hourly earnings for all nonfarm private sector employees have increased by 5.1%, to $32.08.  The problem is that inflation has been accelerating, from around 5% on an annual basis in May 2021 to now more than 8%.

So, real wages are not keeping up, which creates pressure on employers to pay more. Then the question is whether they are in a strong enough competitive position to pass price hikes on to customers, or whether they have to eat those wage hikes and take an earnings hit. If they pass the higher costs on, that keeps upward pressure on consumer prices.

Meanwhile, one indicator, average weekly hours, has been holding pretty steady.  In June 2021, it was 34.8 hours and last month it was 34.5 hours. In manufacturing, it was unchanged, year over year, at 40.3 hours.

“This is often a pretty good indicator of where the overall economy is going to be,” said Lundblad.  “If you look at the correlation between average hours worked, the change, and what we see in real GDP, the correlation is very high. So, this kind of gives us a window as to where we’re headed.”

But there are some signs of softening in indices that monitor the manufacturing and service sectors, he said. And surveys from CEOs, CFOs and small-business decisionmakers are showing similar signs.

“We are starting to see some concerns here. So, it is suggesting something.  Although I want to point out that small businesses, while showing some sentiment concerns, at the same time still have a lot of job postings and are complaining about the difficulty of finding workers. So, it’s almost squarely in this disconnect that I’ve laid out.”

This disconnect extends to some consumer confidence surveys. The Conference Board’s overall index dropped from 103.2 to 98.7 from May to June. But its Present Situation Index, which asks about current business and labor market conditions, barely budged. This suggests that consumers are worrying about what might happen some months from now, even if they feel secure in their jobs at the moment.  This concern about what’s just over the horizon shows up in the University of Michigan consumer sentiment index, which is down 41.5% from a year ago.  Around 79% of those surveyed expect bad times in the year ahead for business conditions, the highest since 2009.

If this all leaves you thinking that things are murky, well, they are.  Last week, the Wall Street Journal had a story headlined: “Our Recession Forecasting Model Is Broken.” Sunday, on the front page of the Houston Chronicle, was the headline: “Houston business leaders aren’t too worried about recession — for now.” So, go figure.

On Wednesday, after you get the June inflation numbers at 8:30 a.m., you can read the latest Beige Book on economic conditions compiled by the Fed’s staff, including the Richmond Fed for our Fifth District. It comes out Wednesday at 2 p.m.  The Fed’s Open Market Committee, which sets interest rates, uses the anecdotal information in the book to complement the firehose of data it gets in the runup to its meetings.

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