The U.S. Labor Market: Is the Anchor For the Fed’s Hiking Cycle Starting To Rust?

Viewpoints

June 14, 2016

Although the return from the depths of the financial crisis in 2008 has been anything but smooth, Federal Open Market Committee (FOMC) members have been able to continuously point to the rapid decline in the U-3 unemployment rate since the middle of 2009 as proof of policy success. While a majority of these improvements in the labor market are presumably behind us, the FOMC still points to its relative strength as a major underpinning of their policy tightening ambitions. Their preferred narrative has been that continued reduction of slack in the labor market would eventually create wage inflation and push Core PCE closer to their elusive 2% target. However, their underlying assumption that the labor market will continue to tighten further from this juncture recently came under fire with the release of the nonfarm payroll (NFP) data for May. Despite a further reduction in the U-3 unemployment rate, a function of reduced labor force participation, not labor market improvement, the report showed a net gain of only 38k jobs for the month of May. This was the worst showing for a single month since 2010 and may be an indication that the trend of 205k average job growth since the beginning of 2015 is starting to abate.

Source: U.S. Bureau of Labor Statistics
research.stlouisfed.org

Source: U.S. Bureau of Labor Statistics
research.stlouisfed.org

Similarly to the most recent round of NFP data, the Fed’s own Labor Market Condition Index (LMCI) has now been in negative territory for five consecutive months, suggesting that labor market deterioration started prior to the poor NFP print released in June. The LMCI is an aggregation of 19 labor market variables (Appendix) published by the Fed’s Board Governors and provides a more robust assessment of the labor market in its entirety than other single series data. Historically, five or more consecutive LMCI prints in negative territory have been somewhat predictive of futures recessions. Since 1976, there have been seven periods prior to this one during which LMCI has printed in negative territory for five consecutive months outside of full blown recessions as defined by the National Bureau of Economic Research. Notably, of those seven occurrences, five came within 12 months of the start of or following the end of a recession. While a sample size of seven isn’t sufficiently exhaustive, it does suggest the recent downward push from LMCI as an outlier, if nothing else, and should be observed carefully.

Source: Board of Governors of the Federal Reserve System (U.S.)
research.stlouisfed.org

Another indicator that has begun to flash warning signals is the growth rate of employment at temp agencies. Temp hiring has generally been a good leading indicator for recessions because temporary workers are first to be let go in economic downturns as firms usually fire their full time employees as a last cost-cutting resort. Historically, when the 3m growth rate has fallen below zero, as it has recently, a recession has soon followed. Previously, temporary employment peaked roughly a year before the 2001 recession and a year and a half prior to the recession in 2008. This indicator does not have a perfect track recover however as the contractions in both 1995 and 2002 proved to be headfakes. It is not all bad news for the temporary employment market however, as Producer Price Index (PPI) data shows that temporary help services do still retain some pricing power despite the overall drop off in hiring. If the labor market is indeed starting to soften meaningfully, it would be expected that the PPI index for temporary services should decline significantly in the coming months.

Source: U.S. Bureau of Labor Statistics
research.stlouisfed.org

Source: U.S. Bureau of Labor Statistics
research.stlouisfed.org

Recent Job Openings and Labor Turnover Survey (JOLTS) data have also told a concerning narrative as of late. While the layoff rate, or the number of layoffs as a share of total employment, was down to 1.1 for April, hire rates fell for the second month in a row. Maybe even more troubling, the ratio of unemployed workers versus job openings using a 12-month average shows that twelve out of the 17 industries tracked in the survey have more unemployed workers than available jobs. Of these 12 industries that have an oversupply of unemployed workers relative to openings, four are directly related to the services industry with another two being potential cogs in a service firm supply chain. Given the fact that nearly 70% of U.S. GDP is tied to the services industry, it is hard to feel positive about U.S. growth during a period of soft demand for labor in the service sectors. The weakness in service sector hiring apparent in this data was confirmed recently by the ISM Non-Manufacturing Employment Index, which also dipped into contractionary territory this month. As the graph on the next page shows, a dip below 50 in this index bears keeping a close eye on as a persistent move lower has coincided with economic weakness in the past.

Source: U.S. Bureau of Labor Statistics
research.stlouisfed.org

JOLTS Ratio of Unemployed vs. Job Openings By Sector

Source: EPI analysis of data from the Job Openings and Labor Turnover Survey and the Current Population Survey
Note: Because the data are not seasonally adjusted, these are 12-month averages, April 2015 – March 2016.

While a labor market downturn is far from a certainty, some of the recent data has indeed been displaying behaviors consistent with past downturns. It will be interesting to observe whether or not these same behaviors will be predictive of the next downturn as the traditional dynamics of growth, productivity, and labor have been challenged following 2008. Furthermore, if this initial softness in labor market data is persistent and does lead to recession as it has on occasion in the past, that does not necessarily imply a recession anywhere near the magnitude of the one seen in 2008. The textbook definition of recession is simply two successive quarters in which GDP is negative and does not necessarily imply negative growth of the magnitude seen in the most recent recession. In either case, recent developments of the labor market would be quite concerning if they were the start of the trend especially since the Fed has built their hiking platform on the foundation of labor market strength. If that foundation starts to wobble, the FOMC’s modest hiking aspirations may have to go by the wayside for a considerable period.

Appendix:

Sources: CB = Conference Board, Help Wanted OnLine Leaving the Board and Consumer Confidence Survey Leaving the Board; CES = Bureau of Labor Statistics, Current Employment Statistics; CPS = Bureau of Labor Statistics, Current Population Survey; ETA = Department of Labor, Employment and Training Administration; JOLTS = Bureau of Labor Statistics, Job Openings and Labor Turnover Survey; NFIB = National Federation of Independent Business, Small Business Economic Trends Leaving the Board. Notes: Some series have been adjusted for methodological changes, data revisions, or calculated from underlying source data by the authors. Composite help-wanted index was estimated by authors following Barnichon (2010). JOLTS hiring and quit rate series were “backcasted” by authors using estimates from Davis, Faberman, and Haltiwanger (2012).


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