Job creation remains strong despite recession risks
There’s plenty of data indicating that the economy is in the midst of a slowdown. Many leading economic indicators point to heightened recession risk — a risk that has been affirmed by the sharply inverted yield for some time.
For now, employers appear to be shrugging that off. The result is a jobs market that not only remains a bright spot in an otherwise mixed picture but one that’s actually regathering some momentum to start the year.
Job creation shocked to the upside in January, as employers added 517,000 new jobs during the month. Revisions to the preceding two months tacked an additional 71,000 on to the single-month tally, lifting the aggregate gain to 588,000. The monthly increase was the strongest since last July and blew past the consensus forecast that called for a gain of around 200,000. It also topped the average monthly gain of 401,000 in 2022. On the strength of that surge in payrolls, the unemployment rate fell to 3.4% — a level last reached in May 1969.
Much has been made of the tightness in the jobs market and the upside risk that creates for inflation. The Fed’s aggressive policy tightening over the past year was aimed first at breaking the back of inflation, but policymakers also see the need for greater labor market slack as a key element to achieving that goal. Today’s report is unlikely to ease the resolve of a Fed, whose vocal jawboning about the labor market and significant policy tightening have still fallen short of what will seemingly be needed to create the desired slack in labor conditions. Lower unemployment is not what policymakers are looking for. The Fed’s forecast for unemployment to rise to 4.6% by the end of this year is still on the table, but it would now require an even sharper reversal in job creation to push the jobless rate to that level.
The report did hold a sliver of good news for Fed policymakers, who can take some solace in the moderate decline in wage growth. Average hourly earnings rose by a moderate 0.3% in January, but the 12-month increase eased to 4.4%. That’s still a robust gain compared to the pre-pandemic period, but it extends a slow but steady decline since early last year. Importantly, easing wage pressures also suggest that there’s room for inflation to continue to recede without large job losses. Whether a full retracement to the Fed’s 2% inflation target can be reached with tight labor conditions remains to be seen but seems less likely.
The decline in unemployment doesn’t necessarily mean that the Fed will come back with a more substantive rate hike after their downshift to a 0.25% increase earlier this week. Much of the effects of the aggressive rate hikes over the past year have yet to be felt across the breadth of the economy. Although the Fed appears poised for a few additional incremental rate hikes, much of the expected tightening in conditions will be a direct — albeit delayed — effect of the Fed’s cumulative rate hikes and ongoing balance sheet reduction.
Perhaps it shouldn’t be a surprise that employers are hesitant to slash their workforce given the uphill battle that they’ve faced in recent years to attract and retain workers. Signs of a coming slowdown are there, but it appears that employers are waiting until they see the proverbial “white in the eyes” of an actual recession to cut staff.
The shock upside in job creation creates a challenge for investors that have been viewing the decline in inflation as a hopeful sign that the Fed may be able to pivot away from tightening sooner than their forecasts suggest. That pivot will undoubtedly come at some point down the line, but investors would be wise to listen to policymakers that have repeatedly warned that they expect to maintain a restrictive policy stance for longer than markets anticipate.
The bottom line? The economy may be slowing, but the labor market didn’t get the memo. Slower wage growth provides some reassurance to the Fed, but the surprising decline in the unemployment rate and strong job creation won’t deter them from their restrictive focus anytime soon.
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