Overlooked Signs the Labor Market Is Softening

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

The major indices notched a third straight week of losses last week as concerns that the Federal Reserve would be forced to maintain an aggressive stance in raising rates persisted from the prior week. Federal Reserve Chairman Jerome Powell’s hawkish comments at a meeting of global central bank leaders two weeks ago in Jackson Hole, Wyoming, set the tone for recent weakness, and a strong Jobs Openings and Labor Turnover Survey (JOLTS) out last Tuesday from the Bureau of Labor Statistics (BLS) reinforced simmering concerns about future Fed moves.

However, as we noted in a prior commentary, demand has dramatically slowed in recent months to match current supply levels and data out last week, including delivery times, costs in manufacturing and housing prices, serve as a counterbalance to the employment headlines. Although we believe that until the Fed sees consistent signs that the labor market is weakening, it is likely to maintain its aggressive stance on rates. But while the headline employment numbers were strong last week, a closer look points to potential easing in a tight labor market in the weeks and months ahead.

The JOLTS report showed a surprising jump in job openings — to 11.24 million, or nearly two openings for each person currently looking for work. Even a relatively benign reading on Friday from the BLS’s other measure of the employment gauge — the Nonfarm Payrolls report — did little to quash fears that the Fed still has its work cut out for it when it comes to taming inflation. The Nonfarm Payroll numbers showed the economy added 315,000 jobs in August, which was in line with expectations and well off the surprising 528,000 jobs added in July. While the level of hiring is still elevated, the latest number is the lowest since April 2020.

While the headline numbers for both reports pointed to a still-tight job market, additional data offer glimmers of hope that imbalances in the labor market may begin to ease, which we expect will lead to lower wage pressures in the coming months. For example, the latest unemployment rate in Friday’s Nonfarm Payrolls data unexpectedly moved higher, to 3.7 percent. The increase was primarily the result of a 0.3 percent increase in the labor force participation rate, meaning an additional 786,000 employees joined the labor market. The participation rate now stands at 62.4 percent — the highest level since March 2022 and the highest reading since the beginning of the COVID pandemic. For additional context, the participation rate was as high as 63.4 percent before the onset of COVID. A return back to pre-COVID levels would result in another 2.8 million people joining the workforce. The latest uptick in participation is a welcome sign and a resumption of a trend we saw shortly after enhanced unemployment benefits expired in September 2021. A rise in labor participation, or a reduction in labor demand, will ease tightness in the job market and take some of the wind out of the sails of rising labor costs. The latest report offers some of both, and that led to a deceleration in wage growth. According to the latest data, wages were up .3 percent compared to expectations of a .4 percent increase. Year-over-year wage growth remained at a still-hot 5.2 percent clip; however, that is lower than the 5.6 percent reading in March of this year. With summer ending and school-aged children heading back to the classroom, we anticipate the participation rate could continue moving higher, which would help ease pressure on job market imbalances that have helped fuel higher wage costs.

Similarly, the so-called “quits rate” included in the JOLTS report dropped to a 14-month low of 2.7 percent. The measure is viewed as an indicator of job market confidence, and about 4.18 million people quit their jobs, down from 4.25 million in June. This reading reached a recent high of 4.51 million in November 2021, which translates to a quits rate of 3 percent.

Additionally, the labor market differential out last week from the Conference Board moved down to 36.6 percent in August from a reading of 36.8 in July. By comparison, the reading was at 47.1 in March. The measure historically has shown a high correlation with the unemployment rate and is calculated based on the views of respondents as to whether jobs are plentiful or hard to obtain. The trend for the reading suggests an uptick in the unemployment rate could be on the horizon.

Finally, the latest employment data from ADP (a private payroll company) offered further evidence that the employment picture, while still robust, may be easing. The report showed weak job growth in the private sector, with just 132,000 positions added. The number suggests a moderating labor market with slowing job growth and wage gains.

While none of the above data is meant to suggest we are on the cusp of a rapid deterioration in the job market, they do point to easing in an area that has remained stubbornly strong and remains a key contributor to inflation.

Wall Street wrap

While employment captured the markets’ attention for the week, other data pointed to encouraging trends in the fight against inflation.

Flattening home prices: Housing prices, as measured by the Case Shiller 20-City Composite Home Index, rose a less-than-expected 0.4 percent month over month in June. On a year-over-year basis, home prices were up 18.65 percent, which was 2.6 percentage points lower than April’s reading. It is noteworthy that the decline coincided with a significant spike in mortgage rates at the beginning of summer. Much like the job market, housing had been stubbornly resilient through much of the year; but as borrowing costs have risen, demand has declined, and prices have begun to come off the boil.  

Slowing cost pressures and faster deliveries: The latest manufacturers data from the Institute for Supply Management (ISM) showed a dramatic slowdown in cost pressures, with the latest reading coming in at 52.5, the lowest reading since June 2020 and down 7.5 percentage points from July. The measure was as high as 92 in the summer of 2021.

The report also showed modest improvements in supplier delivery times at 55.1 (the lowest reading since January 2020), meaning supply chain constraints continue to ease and are returning to pre-COVID levels. For context, the delivery time measure stood at 55.2 in July and at 78.8 last summer. The reading was 65 at the beginning of 2022. The overall PMI reading came in at 52.8 for August, unchanged from July but stronger than market expectations. Surprisingly, the New Orders Index registered 51.3 percent, 3.3 percentage points higher than the 48 percent recorded in July. This is because companies’ pricing power is dwindling. It’s worth noting that just more than half (10 of 18) of the industries in the survey reported growth, which was the lowest level since May 2020. While the report suggests the economy is still expanding, the level of growth is shrinking,

Finally, employment moved back into expansion territory — now at 54.2 after three months of readings below 50. However, some of the uptick may be a result of individuals returning to the workforce. The report noted that only 18 percent of businesses seeking to hire reported challenges in filling roles. By comparison, 35 percent reported difficulty in July.

The week ahead

• Tuesday: Investors will get an update on demand for services in the morning when the Institute for Supply Management releases its latest data on the sector. We will be watching the report for evidence that the trend toward spending on services continues, as well as keeping an eye on delivery times and prices trends.
• Wednesday: The Federal Reserve will release data from its Beige Book. The book will provide recent anecdotal insights into the nation’s economy and could highlight emerging regional economic trends.
• Thursday: The Federal Reserve will release its latest look at the financial condition of consumers through its Consumer Credit report. Consumers’ balance sheets have been an area of strength, and we will be looking to see if consumers have been taking on more debt in response to rising prices. Also, the European Central Bank will meet and is expected to raise rates for a second time (the ECB hiked 50 basis points in July). The market is split on whether this week’s hike will be 50 or 75 basis points.
• Friday: The U.S. Census Bureau will release wholesale inventory numbers for August. We will be looking for signs that inventories are continuing to trend toward pre-COVID levels, which should alleviate price pressures for retail customers.

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