THE JOB MARKET AND THE FED WILL DETERMINE THE ECONOMIC DIRECTION IN THE SECOND HALF OF THE YEAR
Do investors remember when Powell said at the postmeeting press conference that “an unexpected slowdown in the job market would prompt us to cut rates earlier”? But what exactly would this “unexpected” scenario look like? Today, I want to discuss this topic further and try to deduce what Powell’s ideal job market might look like.
First, I often mention that Powell’s observation of the labor market largely depends on changes in the “unemployment rate.” This brings us back to the “Sahm Rule” that we’ve taught before. This indicator is very simple: “If the three-month average unemployment rate rises 0.5 percentage points or more above its low from the previous 12 months, the economy is in a recession.”
Interestingly, CNBC recently published an interview with the scholar behind the Sahm Rule, Claudia Sahm, an economist at the Federal Reserve System. This scholar is warning about the current risks faced by the Fed, believing that if the Fed doesn’t cut rates soon, the U.S. economy could fall into recession.With this formula, I want to lead readers through a calculation to determine under what conditions we can consider the U.S. economy to be in a recession.
First, according to May’s unemployment rate of 4%, looking back two months we see rates of 3.9% and 3.8%. If we average these three months to 3.9%, the difference from 2023’s lowest unemployment rate of 3.4% is still “0.5,” indicating that the Sahm Rule has not yet been established, but is hovering on the edge.
(Source: MacroMicro)
However, given the recent rise in unemployment rates, if June and July’s unemployment rates both remain at 4.1%, then on the day August data for July is released, the Sahm Rule would fully meet the definition of recession. This implies that the U.S. economy may be experiencing a recession. For readers, I believe there are two important concepts to grasp:
Unemployment Rate Level
The current unemployment rate is at 4%. Although Powell hasn’t explicitly stated what level of job market slowdown would be “unexpected” to him, if we use the Sahm Rule as a guide, seeing the unemployment rate hovering above 4.1% would already meet the Sahm Rule’s definition of recession. This is a concept we can keep in mind.
(Source: MacroMicro)
Speed of Unemployment Rate Increase
However, it’s not just about absolute numbers. We also need to consider the speed of change. From the above chart, we can clearly see that the rise in unemployment rates is often unstoppable and steep. If the unemployment rate truly breaks through the average figure as it has in the past and starts to soar, it would be quite thorny. However, unlike in the past, Powell has mentioned multiple times that “the speed of unemployment rate increase is slow, and he doesn’t feel that the entire labor market is heading towards an uncontrollable situation.”
But if we see the unemployment rate rising by 0.1% each month, and it’s continuous rather than fluctuating like 3.9%, 3.8%, 4.0%, then this speed might lead the Fed to believe that the labor market is worse than expected. This could very likely trigger what Powell himself considers “unexpected,” and the Fed might cut rates earlier.
Sahm Rule Definition:
- Calculation method: The average unemployment rate over the past three months minus the lowest unemployment rate in the past year.
- Threshold: If the difference exceeds 0.5, the economy may be entering a recession.
Current situation:
- May unemployment rate is 4%.
- The Sahm Rule has not yet been met.
- If June and July unemployment rates remain at 4.1%, the Sahm Rule will be met, with the timing in August.
All of this will influence the Fed’s response. I assume that in the July Fed meeting, they still want to see more data and don’t plan to cut rates, nor do they provide guidance for the September meeting. If the July unemployment rate released in August is still bad, then it’s very likely that at the August meeting, the Fed might signal to the market.
However, compared to the Sahm Rule, economists tend to use the OECD indicator or the number of initial jobless claims as indicators to predict economic recession, as these reflect changes in national economic trends and involuntary unemployment. Before the Fed truly defines an economic recession through the unemployment rate, readers can continue to pay attention to changes in these leading indicators, looking at both absolute numbers and growth rates, to see if there’s a possibility of early detection.
Chris Zaccarelli, an independent consultant alliance member, said: “We believe that unless we fall into a recession, or the Fed changes its interest rate policy from potential rate cuts to actual rate hikes, the bull market we’re in won’t derail. We expect volatility from now until the end of the year, but don’t expect the bull market to end without changes in the economy or the Fed’s stance.”
THE LABOR MARKET AS SEEN BY THE ST. LOUIS FED
I’ve shared before about the different directions or perspectives we can take when observing changes in the job market. Next, I want to share another observational angle with readers, which is to observe changes in the labor market through the terminology used by U.S. companies in their earnings calls (as far as I know, there are fewer databases or units in Taiwan that statistically analyze the significance of terminology used by Taiwanese companies in their earnings calls, but this is quite common in the U.S.).
When the labor market is tight and short-staffed, companies will more frequently discuss issues such as rising wage costs, labor shortages, and recruitment difficulties in their earnings calls. Researchers at the Federal Reserve Bank of St. Louis use these terms and calls to measure the degree of labor market tightness.
Looking at the above chart, we can see that the blue line represents the curve of labor market mentions in earnings calls, while the yellow line represents the actual labor shortage change curve. Basically, when we observe these two lines together, we find that they have a positive correlation. What does this mean?
Readers can consider that the investments we make now are actually related to activities in the real world. And those who feel these activities most deeply, apart from the consumer end, definitely include the production and manufacturing end. Through the speeches in earnings calls, we can actually sense the changes in the frontline workforce, because companies must constantly face changing market conditions, and their perceptions will be deep.
Rather than observing changes in oil prices or freight rates (of course, I don’t deny the importance of direct observation), if we want to have a multi-faceted perspective to view market changes, directly listening to whether operators are affected by freight rates or oil prices, and to what extent, can be another observational angle.
For example, the earnings reports of non-essential businesses like Walmart, Coca-Cola, or Starbucks are nothing but attempts to present real changes in U.S. retail consumption and to see if there are signs of inflation rebounding through the eyes of businesses. I find this method interesting, as it allows us not to just face cold numbers, but to get closer to the image of economic activities in the real world.
U.S. JOLTS JOB OPENINGS HIGHER THAN EXPECTED
(Source: MacroMicro)
Next, let’s look at the latest U.S. Job Openings and Labor Turnover Survey (JOLTS) report that was just released. From the data, we can see that job openings slightly increased in May, the first time in three months, rising from April’s downwardly revised 7.919 million to 8.14 million, higher than the expected 7.96 million openings.
Simply put, the JOLTS report is a monthly survey of job openings, hiring, and separations (quits, layoffs, discharges) released by the Bureau of Labor Statistics. Unlike the unemployment rate, which measures the supply side of the labor market, JOLTS data helps measure labor demand.
However, although the JOLTS data shows an increase in labor demand, I still think it’s difficult to conclude that the job market is strong from just one month’s data, especially when other data indicate that the job market is slowly cooling. Here, I’m referring to what I consider to be the more important “job openings rate” data.
Overall, are job openings in the labor market important? They are quite important, but there’s another set of even more important data that will be released, which is the job openings in the labor market divided by the number of unemployed people in the entire market. From the above chart, we can see that the purple line ratio is around 1.22 now, which means there are 1.22 job openings for every unemployed person.
The Fed more often uses this indicator or ratio to measure the current activity level of the labor force. If we look to the left for comparison, we’ll find that this set of data has returned to pre-pandemic levels when compared to before the pandemic. Overall, the labor market is indeed still slowing down, at least in the Fed’s eyes.
Bloomberg economist Paul Stewart also believes: “The labor market is cooling. The monthly increase in job openings mainly comes from government positions, and the ratio of job openings to unemployed people has returned to pre-COVID levels. As this ratio continues to decline and the labor market cools, we believe the Fed may cut rates twice this year.”
