Is the Labor Market Turning Over?

The economy continued to add jobs in February, 275,000 of them, to be exact. The employment report exceeded expectations, but the two previous months were revised lower, by 167,000, which means that the originally-reported robust results in December and January look a little less strong than previously thought. Still, average monthly job creation has been about 250,000 for the past 14 months, a solid showing.

The unemployment rate edged up to 3.9 percent in February, as more people entered the labor force. Anything under 4 percent is still low, but we are at the highest level in two-years (January 2022). Additionally, average annual wages were up by 4.3 percent, a slight downshift from the previous month, but a marked drop from the recent peak of 5.9 percent in March 2022. Add in the fact that the quits rate has dropped back to its pre-pandemic level, and you might wonder whether something is lurking in the distance. Is the labor market turning over or is it in transition from red-hot to lukewarm?

Jeffrey Roach, Chief Economist for LPL Financial believes the latter. “Firms will likely slow the pace of hiring in the coming months and shrink payrolls as indicated in the recent layoff announcements,” but that doesn’t mean that a jobs recession is afoot. Amid the transition, some firms are keeping staff, but reducing hours worked, a form of “labor hoarding” according to Roach.

Where does this leave the Fed, as the March FOMC rapidly approaches? We should take Chair Powell at his word, when he says that rates are unlikely to go any higher from here and that the central bank will begin to lower them this year. Before they can pull the trigger, Powell told Congress that officials need “to see a little bit more data” to become confident that high inflation rates are behind us. Most investors believe that the first cut will likely occur at the June meeting.

Powell & Co will look to this week’s release of the February Consumer Price Index for evidence that the inflation rate is coming down. But what if the way we look at inflation is all wrong? A recent NBER working paper, co-authored by Marijn A. Bolhuis, Judd N. L. Cramer, Karl Oskar Schulz & Lawrence H. Summers, asks that very question. After all, the labor market remains on firm footing and inflation is falling, so why don’t people feel better? “This has confounded economists, who historically rely on these two variables to gauge how consumers feel about the economy.” The paper’s thesis is that the culprit is borrowing costs, “which have grown at rates they had not reached in decades.”

You may not realize this, but rising interest rates are not accounted for in either the CPI or the Fed’s preferred inflation measure, the PCE Index. So, if you are one of the millions of Americans carrying $1.13 trillion in credit card debt, and those payments have increased over the past two years, the inflation data do not capture the additional pressure that you are feeling. The paper advances alternative measures of inflation that include borrowing costs, which they say can explain the gap in the economic data and consumer sentiment. Wonky, but interesting, and the best explanation that I have seen to explain the disconnect between sentiment and economic data.