It has been three years since the pandemic shut down parts of our economy. We have gradually, kind of, been repairing our supply chains but the labor market defies description. Some sectors can’t find enough help and others, like technology, are experiencing high-profile layoffs. Inflation is stubbornly high after a year of interest rate hikes. It may be coming down, but it isn’t giving up easily.
Against this muddled backdrop, I listened to Gerald Cohen’s briefing Friday. Cohen, the chief economist of the Kenan Institute of Private Enterprise at UNC Chapel Hill, has a Harvard doctorate and worked at the Treasury. After the Bureau of Labor Statistics releases its employment report each month, he gives an analysis. Friday, the BLS said March unemployment was 3.5%, down from 3.6% in February, not what you’d expect if a recession was close. But there’s a mixed picture behind that number and the other headline data point, the 236,000 jobs that the economy added. Here are some of Cohen’s observations:
Inverted yield curve
One reason Cohen believes a recession is coming in the latter half of 2023 or early 2024 is the inverted yield curve. Usually, longer-term Treasuries have higher yields than shorter-term ones, but now it’s reversed. The 10-year yield minus the three-month is around –1.50 percentage points. It was more negative in the early 1980s, during Fed Chairman Paul Volcker’s successful battle to bring down high inflation, at the cost of a deep recession.
Inflation stayed relatively tame until last year. Since March 2022, the Fed has raised interest rates nine times trying to get it under control.
“[The yield curve spread] turned negative at the end of last year. We had not been saying a recession until then,” says Cohen. “Then we started talking about recession when people were saying the opposite – no landing. That said, we don’t think the recession is going to be deep. We just believe we are going to have a fairly mild recession.”
One of his favorite leading indicators is temporary help. Companies hire temps when they are uncertain about the economy; they also tend to be the first ones laid off.
“We’ve been on a generalized down trend” with temp workers, says Cohen, although the last few months there have been “some squiggles, with the latest month down but the previous month up.” Coming out of the pandemic, the temporary workforce peaked at just under 3.2 million in March 2022. Then it started dropping. It has dropped by 130,000 jobs in a year.
Tech employment has gone from adding more than 30,000 jobs a month a year ago to losing jobs in January and February. In March, tech added several thousand jobs, but this may be an incomplete picture, according to Cohen. The survey numbers were collected right after the collapse of Silicon Valley Bank, which sent a shock wave through tech firms that banked there. The BLS tech numbers for March may not reflect the full impact of the bank failure.
The financial sector was hammered 15 years ago in the Great Recession, losing nearly a half million jobs. Since 2010, it has gained nearly a million jobs, with growth continuing through the pandemic. But in recent months, that growth has stalled; rising interest rates have slowed borrowing. A rise of more than 6,600 financial sector jobs in March may not reflect the impact of the Silicon Valley Bank, the closing days later of Signature Bank, and general skittishness in the financial sector, which can tighten credit.
“We may not be seeing the full extent of the challenges in the financial sector,” says Cohen.
Offsetting weakness in tech and banking is continued growth in leisure and hospitality, which added 72,000 jobs in March. That was lower, however, than the average monthly gain of 95,000 over the prior six months. Leisure and hospitality lost nearly half its 17 million jobs three years ago when restaurants, bars, arenas, and theme parks closed, and falling business travel emptied hotels. The sector is still down 368,000 jobs from pre-Covid levels. “This has been a significant laggard,” says Cohen. Part of what happened is that workers in the sector found jobs in different industries and never returned.
Average hourly earnings were up 0.3% in March for employees on private, nonfarm payrolls, to $33.18. That’s up 4.2% over the last 12 months. This year-over-year increase has slowly come down in the past few months. “There is some weakness showing up in people’s ability to bargain for higher wages,” says Cohen. “The Fed will look at this as a positive,” because it lowers the wage pressure on inflation a little. In the last decade, hourly earnings grew an average of 2.4% per year.
One factor possibly moderating wages in recent months is a drop in job openings. They are still high compared to historical levels, but they dipped under 10 million in February, after peaking above 12 million a year ago.
One reason for this may be that some folks who left the labor force have come back to work. The labor force participation rate moved up to 62.6%. That is as high as it has been in three years. It is still below the 63.3% in February 2020. “The labor force seems to be coming back,” says Cohen.
More people working
Another bit of good news is the increase in the labor force participation rate of folks 25-54. It was at 83.4% in March, up nearly a full percentage point since December, and now slightly higher than February 2020.
A couple of metrics to watch are the weekly initial unemployment claims and commercial and industrial bank loans, says Cohen.
In the most recent week, the jobless claims were 228,000, which was more than the 200,000 forecast. But this is still a low number, says Cohen. During the Great Recession, there were weeks with more than 600,000 initial claims.
Bank lending is a key to economic growth, but rising interest rates and tighter credit standards may be slowing borrowing and slowing down the economy. In the most recent week, commercial and industrial loans fell 1.1%.
“This downward tick right here is suggestive, exactly when you expect it, that the banking system is pulling in its horns and starting to see the earliest consequences of what we can see of the SVB/Signature Bank stresses in the banking system,” says Cohen.
Cohen was asked during the briefing whether he thought the Fed would raise interest rates again when it meets May 2-3. The consensus is that the Fed will go up another quarter-point, to a range of 5-5.25%.
The Fed “made a mistake last year and let some inflation genie out of the bottle, and so they’re fighting for credibility,” says Cohen. If there hadn’t been what he called “cracks” in the banking system like SVB, “I would say they’re going to have to keep going. The more cracks we see, the less likely they’re going to have to keep going.”
For the moment, it looks like the Fed and other banking regulators may have the problems contained. But in September 2008, six months after Bear Stearns collapsed in March, Lehman Brothers went bankrupt, and we were in a full-blown financial crisis. Banks and households may not be as vulnerable to a downturn as they were in 2008, when subprime mortgage defaults led to a wave of foreclosures. Households have a lot of savings, one reason it is hard for the Fed to dampen demand.
“Is the banking system generally strong? I generally believe that’s the case, which is why I’m saying higher interest rates,” says Cohen. Given the Friday jobs report plus the most recent inflation data – 4.6% annualized as measured by the core Personal Consumption Expenditures Price index – he thinks the Fed will raise.
Its goal is 2% inflation.