The Fed expects a strong employment recovery in autumn, for example, NFPs around 1mn. This is because it believes supply factors alone – like unemployment benefits, the lack of childcare, and pandemic fears – are constraining the current numbers, and it expects resolutions to these in autumn. But in my view, the current employment numbers also reflect demand factors that may not improve in autumn because consumer demand is being weakened by falling government benefits and rising inflation. These demand factors are apparent in both the June establishment and the household surveys.
The establishment survey (from which the NFP is drawn) shows that the crisis has hit leisure and hospitality (L&H) employment hardest, with a trough barely above 50% of February 2020 employment, compared with 88% for other sectors (Chart 1). Also, L&H employment was essentially flat in Q4 2020‑Q1 2021, and the recovery restarted only in late Q1 2021. While the recovery in L&H employment is now well underway, it has been slowing in the rest of the private sector.
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Summary
- The Fed expects the labour market recovery to pick up in autumn.
- This is because it believes labour supply is the main constraint, which it expects to ease once schools reopen and pandemic benefits are cut.
- However, June labour market data shows weaknesses are growing and reflect both labour supply and demand factors, with the latter unlikely to improve in autumn.
Market Implications
- Flatter curve, rangebound equities.
The Establishment Survey Highlights Growing Demand Weaknesses
The Fed expects a strong employment recovery in autumn, for example, NFPs around 1mn. This is because it believes supply factors alone – like unemployment benefits, the lack of childcare, and pandemic fears – are constraining the current numbers, and it expects resolutions to these in autumn. But in my view, the current employment numbers also reflect demand factors that may not improve in autumn because consumer demand is being weakened by falling government benefits and rising inflation. These demand factors are apparent in both the June establishment and the household surveys.
The establishment survey (from which the NFP is drawn) shows that the crisis has hit leisure and hospitality (L&H) employment hardest, with a trough barely above 50% of February 2020 employment, compared with 88% for other sectors (Chart 1). Also, L&H employment was essentially flat in Q4 2020‑Q1 2021, and the recovery restarted only in late Q1 2021. While the recovery in L&H employment is now well underway, it has been slowing in the rest of the private sector.
Slowing wage growth in L&H and other sectors suggests this reflects demand rather than supply factors. The slowdown in wage growth is not shown by average wages due to a fallacy of composition: L&H wages and employment growth, while slowing, are faster than in other sectors. In this context, the decline in hours worked in both L&H and other sectors likely reflects slowing demand for labour.
The household survey further suggests demand weaknesses, though supply factors are also at work.
Household Survey Shows Supply and Demand Factors Slowing the Recovery
Since the recovery started in mid-2020, the increase in the duration of unemployment has been striking. While pandemic unemployment benefits could explain part of this increase, it more likely reflects the fast decrease in unemployment. In fact, the behaviour of unemployment spells this time is similar to previous business cycles.
The average unemployment spell is currently about 30 weeks, comparable with mid-2015 (when the unemployment rate was about 5.5%, against about 6% currently). That said, the share of the unemployed out of work for over 27 weeks is much higher this time at around 40%, versus about 15% in 2015. So supply factors and the pandemic unemployment benefits could partly explain the unemployment duration, but only to a limited extent because unemployment duration is in line with previous recoveries.
Furthermore, the composition of flows into unemployment shows that demand factors dominate. Job losses have caused by far the bigger flow into unemployment than job quits, already unemployed workers, or workers newly started looking for a job.
Also, the increase in the number of unemployed in June reflects two factors. First, the number of unemployed who were already unemployed the previous month is no longer falling. In other words, workers are taking longer to exit unemployment, which could reflect both demand and supply factors. Second, the number of unemployed due to losing their jobs is falling more slowly, which reflects mainly demand factors. This is striking as the number of unemployed is still 3.8bn above the pre-pandemic 5.7mn.
NFP Likely to See Substantial Downward Revision
In June, the establishment survey showed NFP increasing by 850,000, while the household survey (used to compute unemployment and participation) showed employment decreasing by 18,000. This resulted in unemployment increasing by 0.3ppt to 5.8% and in unchanged participation and employment to population ratio despite the 850,000 NFP! Whenever there has previously been such a large discrepancy between establishment and household surveys, NFP revisions have been substantial.
Market Implications
Negative NFP surprises could see 10-year yields fall further. This could bring about curve flattening as the Fed is set on starting the taper discussion soon and would likely require strong evidence that the economy is slowing before postponing the taper plans. This evidence may be unavailable until the September/October NFPs. Equities could remain rangebound due to low yields, low headline risks and continued strong support to markets from the Fed.
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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.