July Employment Comes in Weaker Than Expected
Chief Economist Eugenio J. Alemán discusses current economic conditions.
Nonfarm employment numbers seem to be following the same script as the disinflationary process for the Federal Reserve (Fed), that is, they are both slowing, but not enough for the Fed to stop worrying about hitting its 2.0% inflation target going forward and, not enough to end this rate hike cycle. For now, and according to the June Summary of Economic Projections (SEP) ‘dot-plot,’ the Fed still has one more 25 basis point increase for the federal funds rate before the end of this year.
However, this could change after the September Federal Open Market Committee (FOMC) meeting, which is scheduled to take place on September 19-20 as the FOMC is also scheduled to publish a new SEP and there will be an updated ‘dot plot’.
We pointed out, after the nonfarm payroll in June, that there were several indicators in that report that were, potentially, signaling weakness in the jobs market going forward. One of these indicators was the temporary help services jobs sector. That sector shed 20,200 jobs in June and another 22,100 jobs in July. The graph below shows what typically happens to temporary help services jobs before recessions even though 1991 and 2003 were atypical periods. However, the sector tends to signal some weakness in the labor market and this time around it seems that the signal continues to point to weakness ahead.
However, the decline in the rate of unemployment, from 3.6% in June to 3.5% in July, will continue to keep Fed officials on edge regarding the potential threat of a wage-price spiral that could keep inflation higher than the 2.0% Fed target.
Interestingly enough, even the commentary by Fed Chair Jerome Powell that the Fed staff no longer has a recession in its forecast was a funny commentary to us, as it could be argued that not even Fed economists believe in the power of monetary policy to weaken economic activity. Of course, markets took the commentary as an indication of a higher probability for a soft landing, but it could well be interpreted as an inability to slow down economic activity even with current interest rates.
That is, if Fed officials believe that current interest rates will not be able to slow down the economy and it continues to fear the potential consequences of a still-tight labor market on the disinflationary process, then it may be willing to go even higher in terms of interest rates. Having said this, recent increases in the yield on the 10-year Treasury due to the recent decision by Fitch to downgrade the risks rating of the U.S., if sustained over time, could also convince Fed officials that they don’t need to go higher in terms of the federal fund rate.1 We will have to wait until the release of the SEP and the ‘dot-plot’ after the FOMC meeting and confirm the Fed official's view on the future path of rates.
Good productivity numbers should help the Fed
U.S. nonfarm business productivity was higher than expected during the second quarter of 2023, up 3.7%. This pushed unit labor costs up by only 1.6% during the quarter which was very good news for those analysts who believe that inflation will remain higher going forward because of increases in worker wages and salaries. It was also good news for Fed policymakers, who have remained concerned that wage pressures could continue to contribute to keeping inflation higher than the institution’s target rate of 2.0% over the longer term.
However, the news on productivity and unit labor costs is good news for inflation going forward and another indication that even if the economy continues to grow ahead of potential output, i.e., 1.8% per year, inflation will continue to slow down to pre-pandemic levels, which is a far cry from what many have been prognosticating since the COVID-19 recession.
We believe that fears that so-called ‘structural’ changes in the economy will prevent the Fed from achieving its inflation target have been overblown. It is true that productivity numbers are very volatile, and the Fed may not be ready to call its fight against inflation over after the release of this number, but it adds to evidence that inflation, while still not low enough, continues to move in the desired direction.
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