NFP Review – Labour Market Remains Very Tight

Summary

• US nonfarm payrolls (NFP) were below expectations at 187,000 as trend growth in labour supply increasingly constrains employment.
• With labour demand still growing faster than labour supply, the labour market remained very tight. Loosening would likely require below-trend GDP growth.
• Wage growth was higher than expected and is starting to reflect labour market tightness. 

Market Implications

• Market pricing of 125bp federal fund rate cuts by December 2024 is unlikely.

Employment Growth Has Moved to Lower Trend

NFP surprised on the downside at 187,000 rather than 200,000 expected. Two-month revisions were -49,000.

Over the past six months, NFP monthly increases have averaged about 200,000, down from an average of 340,000 the previous six months (Chart 1). The slower growth in employment reflects that most of the workers idled by the pandemic have been mopped up by the recovery. 

Going forward, employment growth will be increasingly constrained by trend growth in labour supply, which has returned to its pre-pandemic rate of about 1.5% YoY (Chart 2).

Labour Market Remains Tighter Than Ever

With labour demand still growing faster than labour supply, the July data continued to indicate a very tight labour market.

Unemployment at 3.5%, vs 3.6% expected and 3.6% in June, remained near its post-1970 lows (Chart 3).  This is also true for U6, the broader unemployment measure that includes workers marginally attached to the workforce as well as part-time workers for economic reasons.

The employment-to-population ratio (EPOP) is a more objective measure of labour market tightness than unemployment since the latter relies on survey respondents declaring that they are looking for a job. The EPOP increased by 10bp in July but remains below pre-pandemic levels (Chart 4).

The EPOP likely has limited upside. The prime age EPOP is already near its post-1970 high, while the EPOP of older workers remains stuck well below pre-pandemic levels. Older workers who have retired are likely not returning to work (Chart 4). The participation rate, at 62.6% unchanged from June, tells a similar story (the participation rate equals the EPOP plus the unemployment rate).

Other indicators also pointed at a labour market that remained tight. For instance, hours worked by production and non-supervisory workers were unchanged and well above pre-pandemic levels (Chart 5).

A cooling of the labour market would require GDP to grow below trend of about 2% (Chart 6).  GDP growth has, however, been accelerating (Q2 2023 GDP: Growth Accelerates). In Q2, GDP growth reached 2.4% QoQ SAAR and the initial Atlanta Fed GDP nowcast for Q3 is 3.9% QoQ SAAR.

Wage Growth Surprises on Upside Again

For the second month in a row, wage growth was a higher-than-expected 40bp vs 30bp consensus. Wage growth has been surprisingly subdued considering unemployment has been at post-1970 lows since Q2 2022. This reflects factors such as:

1. The decline in energy prices that has allowed real wages to increase despite slower growth in energy prices (Chart 7).
2. Wages tend to adjust with a lag to inflation: when inflation rises, real wages tend to fall and vice versa (Chart 8).
3. A transition from the pandemic labour market to more normal labour market conditions. The decline in unemployment during 2020-22 was by far the fastest on record and led to the 2021-22 surge in wages, the largest since the high inflation of the 1970s. With unemployment very low but stable, more normal labour market dynamics are re-asserting themselves, with slower but still high wage growth.

In addition, every episode of wage disinflation since the 1070s has been preceded by a recession.

Market Consequences

The July NFP shows that slower employment growth does not imply a looser labour market because labour demand is still growing faster than labour supply. In addition, the data shows that nominal wage growth is starting to reflect labour market tightness. In turn, this suggests a pass-through to consumer price inflation and an end to the limited disinflation we have seen so far.

This suggests that inflation will prove stickier than the Fed expects and that the four cuts the Fed expects in 2024, predicated on core PCE slowing to 2.6% by end-2024, will not happen. Atlanta Fed President Bostic (dove, non-voter) last week started to walk back the 2024 FFR cuts, stating that he did not see them ‘until the second half of 2024 at the earliest’.

Yet the market is currently pricing about two cuts by mid-2024 and three more in H2 2024.  I do not think these will happen.

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.

Photo Credit: depositphotos.com

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