David Page, Head of Macro Research at AXA Investment Managers, comments on the latest US labor market figures:
- Payrolls slowed to 315,000 in August from 526,000 in July, with a 107,000 downward revision to June and July’s prior readings.
- Household employment rose by 477,000, but the 3 month trend remained materially slower than in the establishment survey.
- Labor supply posted a large 0.5% rise after months of decline. Participation rose back to 62.4% its highest since March.
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- Rising supply helped push unemployment higher to 3.7% from 3.5%, its highest since February.
- Average earnings rose by just 0.3% on the month, their softest since April. The annual rate rose by 5.2%, but the annualised rate of 3.7% was around a pace consistent with the Fed’s 2% inflation target.
- These are the first consistent signs that the labor market is easing in line with softening US activity.
- The Fed will require further proof of softening before adjusting policy materially, but on balance these figures are consistent with a 50bp September Fed hike.
- We expect further labor market deceleration. If so we think the Fed will stop tightening at 3.5% in December.
- Markets reacted positively to data that suggested a less aggressive Fed.
Tightness In The Labor Market
August’s employment report was a little more benign across a range of metrics. While headline payrolls fell to 315,000, broadly in line with expectations, and July’s increase remained an outsized 526,000, a bigger downward revision to June meant payrolls over the past 3 months were some 100,000 less than expected.
Meanwhile an increase in the participation rate, undoing successive months of declines and rising back to levels not seen since March, appears to have alleviated some of the tightness in the labor market, unemployment rising back to 3.7%.
Finally, pay growth slowed in August to just 0.3% on the month – an annualised pace that the Fed could live with. On balance, the report suggests an easing in the labor market more consistent with the weakening in economic activity.
The Fed will not sound the all clear on this report. But it probably gives the Fed the confidence to ease by a less extreme 50bps at its September meeting.
Payrolls growth slowed in August to 315,000, slightly above market forecasts for 300,000, but much lower than July’s outsized gain, which was revised marginally lower to 526,000 from 528,000.
However a more material downward revision was made to June’s increase, now seen lower at 293,000 from 398,000 originally meaning that the previous two months posted net downward revisions of 107,000.
While payrolls growth still far exceeded other indicators – including the recently published ADP survey – this is a clear softening. By contrast, the alternative measure of employment – the household survey – recorded a faster 477,000 increase in August.
This measure has been materially weaker than the establishment survey in recent months – indeed the 3 month trend is still lower at 102,000 compared with the 378,000 for payrolls – however the marked divergence may now be easing with some convergence from both measures as we expected.
Labor Supply Rises
Accompanying the sharp rise in household employment came an associated rise in labor supply. Supply rose by 0.5% in August, the largest single month increase since January.
Recent months had seen falling labor supply, with April to July average a 0.1%/month decline. This had contributed to a fall in labor participation to just 62.1% in July from 62.4% in March.
This lack of labor supply had contributed to the tightness of the labor market and underpinned the drop in unemployment back to 3.5%.
With the welcome increase in labor supply this month, participation rose back to 62.4% and unemployment rose to 3.7% its highest since February. The outlook for labor supply is extremely uncertain, but we continue to expect to see participation rise over the coming months, something that would further ease the tightness of the labor market.
Consistent with both the above softening in employment growth and rise in labor supply, earnings growth slowed this month to just 0.3% – a little below the consensus forecast of 0.4%.
This is the joint slowest increase since April and even if the annual rate remains an elevated 5.2%, the annualised rate of 3.7% is close to a pace that is consistent with the Fed’s 2% price stability target.
After several months of elevated pay growth, the Fed will require much more evidence of easing pay pressure before it considers relenting in its monetary policy tightening. This is even more so as these preliminary estimates can and often are revised.
However, a softening in pay growth, along with other signs of easing in the labor market, is consistent with a broader easing in labor market tightness.
Fed's Tightening Policy
Today’s labor market release comes at a critical juncture for Fed policy. While inflation remains high and risks to inflation expectations elevated, the Fed must continue to tighten policy.
However, the Fed will not continue to hike – and certainly not in 75bps clips – until inflation returns to 2%.
Rather the Fed will have to gauge when the tightening in financial conditions is sufficient to allow inflation to return to target over a time period that it considers acceptable.
Key to gauging that is how much domestically generated inflation pressure the labor market is creating. The tightening in financial conditions generated by Fed hikes to date has had a visible impact on growth and we now expect the economy to undergo a mild recession.
This weakening in activity now appears to be impacting the labor market. With the first consistent evidence of some impact here, we think that the Fed will feel comfortable slowing its hiking to 50bps in September (barring an ugly surprise in the next inflation print).
From then on the pace of further tightening will depend on the pace of slowdown in the labor market. We expect further deceleration with payrolls growth slowing towards 100,000 by year-end.
Such a slowdown we think will allow the Fed to ease its tightening over the remainder of this year and we forecast the Fed Funds Rate closing the year at 3.50%. However, should the labor market fail to slow – as was the case in the months before today’s release – the Fed will likely have to do more.
Markets reacted consistent with their recent theme: since Jackson Hole, the market has increasingly worried about rising Fed aggressiveness which has led to a tightening in financial conditions.
Today’s report was the first question of that aggressiveness.
As such end-year Fed rate expectations fell by 9bps (to a little under 3.75%), 2 year and 10 year Treasury yields fell by 7bps and 4bps to 3.43% and 3.22% respectively and the dollar eased back by 0.2% against a basket of currencies.
