The June jobs numbers came out Friday from the Bureau of Labor Statistics. It was a strong report, 209,000 jobs added to the economy. But it wasn’t as strong as the 240,000 expected. It certainly wasn’t as strong as the ADP estimate on Thursday, 497,000 jobs.
I wanted to go beneath the headline number to get a sense of where the economy is headed, and what the Federal Reserve might do at its meeting in two weeks and beyond.
The markets are mortal-lock certain the Fed will go up another quarter point in its relentless (since March 2022) effort to rein in inflation. The Fed may be done after that, or not. Wednesday morning, we’ll see the Consumer Price Index for June, a fresh read on the inflation that’s had us in a vise since Spring ‘21. We don’t know if the Fed is going to be able to ease inflation back in the box or if it has to tank the economy, like Fed Chairman Paul Volcker in the early ‘80s. For clarity, I watched a briefing Friday morning conducted by Gerald Cohen, the chief economist of the Kenan Institute of Private Enterprise at UNC Chapel Hill. Here are some of my takeaways from that.
The Fed’s problem
The problem for the Fed is that the labor market is very tight, with a June unemployment rate of 3.6%, and that has led to wage increases that have kept overall inflation stubbornly high. Average hourly earnings came in hotter than expected in June, and over the past 12 months, have gone up around 4.4% for nonfarm workers. Remember 2% annual raises? Over the last three years, wages are up a total of more than 14%. It is hard to get inflation down to the Fed’s 2% annual goal when wages are rising like that, because businesses are trying to pass those increases on in prices.
The pandemic had set back job growth for a while, but that is over. “We’re almost aligned where job growth should have been if we’d continued to have the pre-Covid trend,” Cohen says. There are sectors, such as state and local government and leisure and hospitality, that haven’t come back to pre-Covid peaks, but other sectors, such as manufacturing and information services, have surpassed those levels.
“That means, effectively, we’ve come back from Covid. And in February 2020, the labor market was quite tight. That means the labor market is hot and tight, and that’s one of the reasons the Fed raised rates so much and will continue to raise rates.”
The labor force
The narrative that people don’t want to work isn’t entirely so. In the prime working age group – 25-54-year-old folks – people are working. “We’ve now surpassed the pre-Covid labor force participation rate,” says Cohen. It was 83.2% last month for that group, slightly higher than February 2020. Nearly 90% of men in that age group are working, and about 75-80% of women.
One problem is that a lot of older workers retired. That was going to happen anyway because older baby boomers started hitting retirement age more than a decade ago, but the pandemic accelerated the trend. “Demographics are weighing on our labor force participation rate. There have been retirement choices post-Covid. People are saying, ‘Look, I’m kind of leaving the labor market. I’ve changed my view on work.’” Maybe there are incentives that would bring them back, and make more workers available.
Immigration increased last year for the first time since 2016, and more immigration would loosen up the labor market, Cohen says. Immigration, as controversial as it has become, has been one of the main drivers of our economy. Between 1965 and 2015, 55% of our population growth was from new immigrants, their children and grandchildren. But there are significant political obstacles to increasing the number of immigrants and a lot of debate over the right set of immigration policies.
Stubborn inflation
One challenge facing the Fed is that headline inflation numbers can be misleading. A leveling off of food and declines in energy prices can make it look like the Fed has made progress. The PCE index – which is the inflation number most closely tracked by the Fed – showed inflation at 3.8%, year over year, in May, down from 5% in February. But core PCE, with food and energy excluded, was 4.6%, roughly where it has been hovering so far this year.
“The headline numbers have come down, and people are saying, ‘Look, the Fed is done or close to done, they’re coming down. But if you exclude food and energy prices, which drove some of that big increase and has driven the vast majority of the big decrease, you’re seeing inflation stubbornly stuck at around 4%.”
What should the Fed do?
At the June meeting of the Federal Open Market Committee – the Fed panel that sets interest rates – FOMC members left their Fed Funds target range unchanged at 5%-5.25%. But the median forecast of Fed governors and regional bank presidents was for a couple more rate hikes by the end of this year, and a rate around 5.6%.
The median forecast also predicted that after being done with rate hikes by the end of the year, the Fed would get core PCE inflation this year down to 3.9%, and then down to 2.6% in 2024 and 2.2% in 2025. This would give the Fed room to cut rates in 2024 and 2025, and GDP would grow between 1% and 2% annually over the next two years, the so-called “soft landing” scenario. In this forecast, if there’s a recession, it would be mild, with unemployment in the 4.5% range, about 1 percentage point higher than today.
This all assumes that the Fed’s forecast is right, that the 10 rate hikes since March 2022 – plus a couple more – will slow down the economy enough to bring inflation down to its 2% target.
But hanging over all this is whether the Fed waited too long to tackle inflation. As Cohen put it Friday: “Are past mistakes forgiven?”
“Is the tightness in the labor market that we’re seeing, and the high inflation, the result of these past mistakes, and should [the Fed] be tighter [in its monetary policies] for longer?”
Numbers to consider
If you are looking for signs of a slowdown, the BLS Friday reported that it was revising the April and May reports down significantly, by 110,000 jobs. This happens, as the BLS gets more data from businesses and makes further seasonal adjustments.
“That trend is worrying to me,” says Cohen.
And then there was a decline of 13,000 in June in temporary help workers. “Temp help jobs are the first to be hired and the first to be fired,” he says. Temporary help peaked last year and has been declining steadily.
Also, initial jobless claims for unemployment insurance have been trending up over the past six months, modestly. Cohen also pointed Friday to the declines in gross domestic income in Q4 ‘22 and Q1 ‘23, which doesn’t get nearly as much attention as GDP, gross domestic product, which has stayed positive, but is something to watch. (GDI and GDP are just two of around nine indicators that the National Bureau of Economic Research looks at when deciding whether we are in a recession, not two consecutive quarters of negative GDP, a common, but incorrect, belief.)
And then there is that persistent inverted yield curve. Shorter-term treasuries are yielding a higher interest rate than longer-term ones, which usually means bond traders foresee a downturn further out that is going to depress borrowing demand. Since the mid-1960s, a negative spread between the 10-year and three-month treasuries has accurately predicted a recession, and this inversion happened again last fall and continues. Since late last year, as a result, Cohen has been predicting a recession in late 2023 or early 2024, because there’s a lag of 12 to 18 months between the inversion and a recession.
“200,000 is a strong enough number to say we are not in a recession, and the likelihood that we go into a recession next month and the month after . . . is very low. But if this increase in jobless claims, if this temp help number is indicative, maybe in six months, maybe in 12 months.” Because of, in part, the high level of household savings, the downturn will likely be mild, he says.
