US Labor Market Hot Despite Rate Hikes, Unemployment Stays at 3.6%
Friday’s jobs report from the Bureau of Labor Statistics reveals an unchanged unemployment rate of 3.6%, for the 4th consecutive month since March. This translates to a steady 5.9 million unemployed in June. For comparison, pre-lockdown unemployment, in February 2020, was at 3.5%, or 5.7 million unemployed.
Increase in Nonfarm Jobs More than Expected
Nonfarm jobs increased by 372,000 in June, across hospitality, health care, leisure, and business services. This exceeded the previous estimate of 250,000. Those who are long-term unemployed, over 27 weeks, account for 22.6% in June, or 1.3 million, which is 215,000 higher than in February 2020.
However, part-time unemployment decreased by 707,000 in June, to 3.6 million, which is under the February 2020 level of 4.4 million. Overall, the labor participation rate at 62.2% is slightly lower than the February level of 63.4%.
In terms of job vacancies, there are 1.9 jobs available for every unemployed person. This plays a big part in how companies view wages, and how the Federal Reserve sees its battle against inflation.
Federal Reserve to Likely Continue Increasing Rates
The stated mission of the Federal Reserve, the world’s most powerful central bank, is two-fold: price stability and maximum sustainable employment. The 8.6% inflation rate, the highest since 1981, clearly disrupted the Fed’s first mission. After all, it is over 4x the original inflation target of 2%.
The importance of re-establishing price stability was expressed in the latest Federal Open Market Committee (FOMC) minutes, dropped on Wednesday. The Fed’s governors mentioned “inflation” 90 times, emphasizing the need to proceed with more interest rate hikes.
“Participants concurred that the economic outlook warranted moving to a restrictive stance of policy, and they recognized the possibility that an even more restrictive stance could be appropriate if elevated inflation pressures were to persist.”
The stable unemployment rate, which is effectively at the pre-lockdown level, means that the Fed has more leeway to continue with quantitative tightening. This translates to a majority agreement between the Fed’s Governors that “it was appropriate to raise the target range for the federal funds rate 75 basis points.”
It is also no secret that Fed Chair Jerome Powell previously expressed the need to cool down the economy by suppressing wages.
“By moderating demand, we could see [job] vacancies come down, and as a result—and they could come down fairly significantly and I think put supply and demand at least closer together than they are, and that that would give us a chance to have lower—to get inflation—to get wages down and then get inflation down without having to slow the economy and have a recession and have unemployment rise materially. So there’s a path to that,”The WSJ press transcript on May 4th.
In other words, the Fed’s interest rate hikes raise the cost of capital, which in turn suppresses consumer demand. This affects wage growth, which has already been lagging behind inflation.
Nonetheless, average hourly earnings rose 5.1% on an annual basis, which also beats estimates. In the end, the Fed’s stated mission of maximum sustainable employment has embedded leeway to prioritize price stability. Chief investment strategist at Nuveen, Brian Nick, noted as much.
“If you get falling unemployment and the [workforce] participation rate also going down, you get that overheating mix that gives the Fed the green light to keep going and that would be an unambiguous negative for the markets.”
With the labor participation rate effectively within the range of pre-lockdown February 2020, and June’s jobs report countering recession fears, this means that another 75 basis point interest rate hike for July is almost assured.
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How did the Market Respond to the Jobs Report?
Real GDP already contracted by 1.6% in Q1 2022, missing a 1% increase estimate. Further contraction of 1.9% in Q2 is expected from the previous forecast of 4.2%, based on record low consumer sentiment.
Technically, this puts the economy on the path to recession. However, it is indicative that the FOMC minutes did not mention recession once. For the markets, this is a lose-lose scenario. If the jobs report hadn’t beat estimates, the stock prices would reflect this as recession certainty.
On the other hand, the jobs report did beat estimates, giving the Fed more leeway for aggressive interest rate hikes. This too negatively affects the markets. The immediate reaction to the jobs report is rather muted, with only S&P 500 experiencing a slight dip during the day.
However, much is expected of the next inflation report, coming on July 13th. If there is a further Consumer Price Index (CPI) spike beyond May’s 8.6%, this would mean we haven’t even reached the peak. In that scenario, the Fed would have to resort to recession as the main tool to suppress consumer demand, so that too few dollars would start chasing too many goods.
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