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Issue 48: Labor Market Cooling

September 5, 2023

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This Week’s Highlights

  • Barrage of data shows job market softening
    The JOLTS report, independent ADP data, and BLS nonfarm payrolls released throughout last week showed a bigger slowdown than expected in companies hiring, workers quitting, and wages rising. Traders bet such tame labor market data would be enough to keep the FOMC at bay in September.
  • Fed’s preferred inflation gauge ticks up again
    A report on Thursday showed PCE inflation rebounding modestly in July, with headline PCE inflation growing 3.3% year-over-year, up from 3.0% the month prior. That rise was largely a result of base effects we tipped weeks ago, widely expected by economists, and unlikely to sway the Fed.
  • Are US consumers running out of steam?
    The same report showed changes in US households’ real income and expenditures, which revealed Americans earning less and spending more in recent months. We see that trend as unlikely to persist and, along with flagging consumer confidence, the principal risk to a soft landing.

The CIO’s Take: Positive data on the labor front validate our decision last rebalance to make a measured increase to equity exposure, though we’re still cautiously watching for sustained progress to provide a more decisive ‘risk-on’ signal. Given evidence of labor conditions easing and PCE inflation in line with forecasts, we see the Fed standing pat at the September FOMC, but don’t expect cuts to come soon—and don’t count out another hike by year end. Overall, while we’re happy with the trend in macro data, we see rich developed market equity valuations, signs the American consumer might finally be hitting a wall, and attractive Treasury yields as justifying our current tilt toward more defensive allocations: underweight US stocks, overweight fixed income.

Labor Market Cooling

JOLTS report shows hiring, quitting moderating
Tuesday’s Job Openings and Labor Turnover Survey (JOLTS) report from the US Bureau of Labor Statistics (BLS) was the first jobs data in a week full of announcements on US labor conditions. Given the role of a tight US job market in driving inflation over the last two years—and Powell’s insistence at Jackson Hole that the central bank would “proceed carefully” and “assess [its] progress based on the totality of the data”—many saw last week’s labor market updates as a key piece of the puzzle in the Fed’s decision on rates over its next few meetings. If investors were looking for signs of cooling, the JOLTS report certainly started things off on the right foot, with job openings falling by 338K over the last month to end July at 8.8 million openings, significantly fewer than the 9.5 million forecast by economists, and the lowest reading since March 2021. The rate of resignations, often viewed as a measure of American workers’ confidence and a more predictive measure of labor market strains, fell to 2.3% in July, a level not seen since January 2021.


ADP, nonfarm payrolls reinforce softening story
Further evidence of a cooling labor market rolled in through the rest of last week. On Wednesday, the independent ADP National Employment Report came in showing 177K jobs added in August, modestly short of consensus estimates of 200K new jobs for the month, but a significant drop-off from the 371K jobs added in July; the report also showed growth in pay declining. ADP chief economist Nela Richardson noted that the August data were “consistent with the pace of job creation before the pandemic…moving toward more sustainable growth in pay and employment”, as pandemic-era distortions seem to be finally fading. While data from the BLS on Friday—the last labor market update of the week—put growth in nonfarm payrolls up 187K for August, slightly above analysts’ expectation of 170K jobs added, the unemployment rate popped to 3.8%, well above economists’ 3.5% forecast, and wage growth came in at 0.2% month-over-month, slightly short of the 0.3% consensus estimate.


How will the Fed read last week’s jobs data?
On the whole, last week’s data have to be seen as a positive for the Fed’s fight against inflation. Not only are we seeing signs of a job market “rebalancing”, but it’s so far happening in a way that keeps a soft landing narrative—whose odds we agree have increased in recent months—intact, as gradually loosening labor conditions preserve the possibility of inflation softening without massive job losses and a huge hit to growth. This isn’t a foregone conclusion, however, and we still see equities as priced too optimistically given the risk that August’s progress isn’t sustained. After all, last month’s retreat comes from historical highs, and even a significant negative surprise on wage growth in August still puts the year-over-year increase in pay at 4.3%, well above what we imagine the Fed regards as ‘mission accomplished’. Even so, we agree with futures traders who priced the chances of a hike in September at a mere 6% by the weekend (see below), expecting the Fed will hold at their next FOMC.

Figure 1 Likelihood of September Fed Hike

Inflation and Fed Policy

No big surprise in PCE inflation
The only break to last week’s decline in market expectations for a September rate hike came on Thursday and corresponded with the Bureau of Economic Analysis (BEA) release of the personal consumption expenditures (PCE) index, the Fed’s preferred gauge of underlying inflation. Both headline and core PCE for July showed a monthly increase of 0.2%, each spot-on with analysts’ forecasts. That represented a bounce back in year-over-year headline PCE inflation—a result of those ‘base effects’ we’ve been talking about in Perspectives—which rose from 3.0% in June to 3.3% in July. Core PCE, excluding food and energy, likewise ticked up 0.1% to 4.2% year-over-year in July. If one drops housing costs from the basket to arrive at so-called ‘super-core’ PCE, prices were 0.5% higher for the month, up from 0.2% in June, though that jump was mostly attributable to temporary effects, such as a spike in financial services prices related to surging stocks in July. Taken together, while prices are still rising faster than the Fed’s target, perhaps explaining the modest Thursday bump in likelihood of a September hike, we see these trends as consistent with “progress” chairman Powell referenced at Jackson Hole the week before.


Americans earning less, spending more
It was another set of data points in Thursday’s full report on PCE that we found most interesting: items focusing on the health of US consumers. Following a robust gain of 0.6% in June, consumer expenditures surged again in July, growing 0.8%, the biggest rise since the beginning of this year, supported by the “Barbenheimer” movie phenomenon and a record-breaking concert tour by Taylor Swift. Some of those one-offs might explain robust outlays by consumers despite recent reports of sagging sales at retailers like Home Depot, Target, and Dollar General. But at the same time, personal income only saw a 0.2% increase in July. Adjusting for inflation, real disposable personal income actually fell by 0.2% for the month, while real consumer expenditures grew by 0.6%—marking a considerable disconnect between desire and ability to spend—with data also showing Americans’ personal savings rate dropped from 4.3% in June to 3.5% in July (see below).

Figure 2 Savings Fall as US Consumers Keep Spending

As we’ve remarked before, the American consumer has been key to driving robust growth despite over a year’s worth of Fed tightening. Vibrant consumer spending has buttressed corporate earnings against a bigger contraction and, in our view, the health of US households remains the key to any hope for a soft landing. Based on data like those above, analysts are speculating excess household savings could actually go negative by the end of Q3 if recent trends persist, putting some of the more bullish scenarios for this cycle’s end at jeopardy. Indeed, especially with a potential softening of the labor market—another key ingredient to getting inflation down and the Fed off the market’s back—we see current levels of spending as unsustainable.


Consumer confidence and Fed policy
These anxieties seem to be well reflected in last Tuesday’s release by The Conference Board of its popular consumer confidence index, which dropped 7.9 points to 106.1, versus expectations of a mere one-point decline. Confidence had risen over the last two months, but flagged in the face of fears on the labor front—consistent with jobs data reviewed in the previous section—as well as continued inflation, which was underscored in the last month by rising gas prices, sure to register with consumers amidst summer travel. All of that lines up with The Conference Board’s ‘Expectations Index’, representing more of a short-term outlook on the US economy, which fell from 88 to 80, landing at a level typically associated with recession. Ultimately, weakness starting to show in labor conditions and consumer sentiment should be enough for the Fed to pause again in September, though there’s not nearly enough evidence for us to call the peak of this policy cycle.