The U.S. Bureau of Labor Statistics released its July jobs report Friday and I looked at the data for clues about where the economy is headed. It seems strong, but there are signs that it may be slowing down.
That is challenging for folks who have to make plans. Some of you in business are taking the first pass at 2024 budget numbers. When there is uncertainty, companies often assume revenues will be flat or down, and budget accordingly. The problem is expenses won’t be flat.
For some clarity, you could listen to Friday’s briefing by Greg Brown, who is executive director of the Kenan Institute of Private Enterprise. Brown spoke about the jobs report, but he also talked about the mixed economic outlook generally. Here are some of the highlights from the jobs report and a link to the roughly 30-minute video of Brown’s commentary.
– The economy added 187,000 jobs in July, which was below the 200,000 expected. The unemployment rate dropped to 3.5% from 3.6% in June. The economy had been adding 500,000-plus jobs a month in 2021 and in the 300,000-plus range in 2022, as it recovered from the pandemic. Since March, the average has been in the 200,000 range.
“We’ve definitely seen softening in the payroll numbers,” says Brown.
“Those are still pretty strong numbers,” says Brown. And at 3.5%, “This is basically the lowest number we’ve had for the unemployment rate over the last 50 years.”
– One reason the economy is able to add jobs is that prime-age folks – 25 to 54 – have been coming back into the labor force since the pandemic hit 3½ years ago. “We’ve had millions of people come back into the labor force over just the last year.” The labor force participation rate among prime-age workers, at 83.1%, is back where it was in February 2020. The rate for prime-age women is the highest it has been, at more than 77%. The same age group of men is at around 89%, around pre-pandemic levels.
But the overall labor force participation rate for all workers, 16 and above, is still stuck at 62.6%, below the pre-Covid level of 63.3%. That’s because many folks 55 and over left the workforce and are not likely to come back. “They’re sort of permanently gone,” says Brown.
– The tight labor force is reflected in wages. They are running hotter than the Federal Reserve would like and helping to keep inflation high. The July jobs report showed average hourly earnings were up 4.4% over a year ago. After wages started going up between 5% and 6% in 2022, they started to level off a little. But they have still been going up faster than the 2% annual raises of a decade ago. Until the Fed gets inflation back down to its target of 2%, it is going to be hard to get workers to accept raises below 4%. And it is going to be hard to get inflation down until raises cool off, because companies try to pass higher labor costs on to customers. It is an inflationary impasse that may require a Fed-induced recession to break, not the soft landing some envision.
— The July numbers showed some hints of a softening economy. Temporary help continues to drop, down 22,000 in July and down 205,000 since the category peaked in March 2022. Temps tend to be the first to be let go when the economy loses momentum. Also, manufacturing, which had strength coming out of the pandemic, seems to have stalled somewhat. In July, it lost 2,000 jobs; the sector added 1 million employees since mid-2020, but in recent months, growth has slowed.
– One sector that continues to add jobs is health care, 63,000 jobs in July, more than the average monthly gain of 51,000 the past 12 months.
“That was an area that was really decimated during Covid,” says Brown. A lot of elective care was curtailed and many people stayed away from health care facilities early in the pandemic. Employment dropped around 1.6 million workers, nearly 10%, in two months. The sector has regained its workforce and now has more than 400,000 more employees than in February 2020.
– The Fed has raised its target Fed Funds rate 11 times since March 2022 to slow down the economy and get inflation back to its 2% target, as measured by the Personal Consumption Expenditures (PCE) Index. The latest reading on that, for June, showed the headline number has come down to 3%, year over year, but the core rate – excluding food and energy – was running at 4.1%.
There are hopes that the Fed may be done raising rates, and the economy can avoid a recession. Brown isn’t so sure. Inflation has come down, but its descent has slowed. The core rate has been stuck above 4% for months.
“That rate of decline has leveled off and it’s leveled off at an inflation number that’s above the Fed’s 2% target,” says Brown.
– Brown says the probability of a recession the rest of this year is “probably very low.”
But he and his colleagues at Kenan believe the Fed has more work to do. Inflation is “quite persistent,” and the economy continues to be stronger than expected. “That strong economy could translate into higher rates by the Fed . . . eventually tipping the economy into a recession.
“From our view, we’re not out of the woods yet in terms of a risk of a recession over the next 12 months.”
One way to think about the current level of interest rates is to look at some history, says Brown. If you look at the Fed Funds rate on an inflation-adjusted basis, “There’s still some evidence that the Fed could be behind the curve,” according to Brown.
“If we go back to the Gulf War recession back in 1990 and the dot-com bubble bursting [in 2000] and the global financial crisis [in 2008], in each of those cases, the Fed had raised the real Fed Funds rate quite a bit higher than what it is right now. And the unemployment rate is even lower than it was prior to those recessions.
“And so, in this sense, you might expect that the Fed potentially still has more work to do on the rate side.”
– What makes policy difficult for the Fed is that the economy takes a while to respond to higher interest rates and tighter credit. It doesn’t know precisely when it has done enough, and “historically the Fed has tended to overdo it,” says Brown. One of the things propping up the economy is that consumers have a lot of money to spend, with cash deposits and money-market holdings by households “well above where we were pre-Covid,” says Brown. Retail numbers have been strong and housing starts have been rebounding. Job openings are lower, but still high. But there has been softening in bank lending and the 10-3 yield curve has been inverted since last Fall, which is typically a recession warning.
“In a nutshell, continued strength, maybe too strong. Maybe continued Fed tightening that would lead to a recession at the beginning of next year,” says Brown. “Of course, the question isn’t ‘Will there be a recession?’ It’s ‘When will there be a recession?’