US Labour Market Tighter Than Appears

Summary

• Net hiring, a better indicator of labour market tightness than hiring or quit rates, remains at the average of 2019.
• The unemployment increase reflects labour market normalization and a surge in migrants, who take longer to find a job.
• The recent employment growth slowdown likely reflects a slower increase in migrants (i.e., labour supply).
• Because this is accompanied by a tighter labour market and inflation risks, the Fed may be unable to respond to a decline in labour supply with rate cuts.

Market Implications

• I expect the Fed to remain on hold in 2025, against markets pricing about two cuts.

Net Hiring Flows Still at 2019 Average

In his latest presser on 18 December, Fed Chair Jerome Powell stated ‘conditions in the labor market are now less tight than in 2019’ and that ‘the labor market is not a source of significant inflationary pressures.’ In this note, I argue current labour market tightness is actually not that different from 2019 and that the labour market could easily become a source of inflationary pressures.

FOMC members most often cite JOLTS to support their cooling thesis, specifically the decline in quits and hiring rates and in the vacancies per unemployed. However, vacancies per unemployed remain near the 2019 average, and the ratio of hires to openings, in my view another indicator of labour market tightness, remains well below the 2019 average. Also, over the past few months both indicators have moved in the direction of labour market tightness (Chart 1).

Furthermore, while hiring and quit rates have fallen relative to pre-pandemic, so has the layoff rate (Chart 2). The better indicator of labour market tightness is the net hiring rate (hiring minus layoffs and quit rates) that remains at the 2019 average.

I think the lower labour market flows reflect that, having experienced strong labour shortages during the pandemic, employers are now retaining workers. This is how I read the tightening of the spread between the wage growth of job switchers and stayers (Chart 3). The latter slowing less than the former could reflect retention efforts.

The breakdown of the relationship between temporary work and unemployment supports this (Chart 4). Declines in temporary employment were leading indicators of the 2001 and 2007-09 recessions. By contrast, this time temporary work has declined sharply but unemployment has stabilized. Rather than a weakening labour market, the decline in temporary work reflects an unsustainable increase in temporary employment during the pandemic as well as, post pandemic, the conversion of temporary workers into permanent employees.

Higher Unemployment Reflects Surge in Unskilled Labour Supply

As Powell stated in December’s presser, unemployment has increased but remains low. At 4.2%, unemployment is higher than the 2009 average of 3.7%. In addition, the recent unemployment increase reflects labour market normalization: 2022’s unemployment rate low of 3.4% was the lowest since the 1950s.

In any event, the 2009 and the current unemployment rates are not fully comparable because they reflect different labour supply condition. This time, an illegal immigrants surge, who take longer to find jobs than more established immigrants or native-born workers, is behind the unemployment increase.

Evidence of this is the rise in the foreign-born unemployment rate above that of native-born workers (Chart 5). Before the immigration surge, foreign unemployment was below native born. The reversal of the relationship reflects the higher rate of unemployment of recently arrived migrants relative to more established one.

Also, all the unemployment rise since 2023 has been in uninsured unemployment (Chart 6). This is consistent with recent migrants being unable to collect benefits due to their legal status or a lack of contribution. The insured unemployment rate at 1.1% is comparable to the 2019 average of 1.2%.

The decline in the job finding rate through the 2019 average may well reflect the immigration surge and could explain the increased duration of unemployment (Charts 7 and 8). Also, the share of unemployment accounted for by new entrants to the labour force remains comparable to 2009, which shows workers still find it attractive to enter the labour force (i.e., have positive expectations of finding a job).

Lower NFP Reflects Falling Labour Supply

The nonfarm payrolls (NFPs) slowdown is another sign of labour market cooling. However, an unemployment increase accompanied the strong payrolls of 2023-24, suggesting these were driven more by an increase in labour supply than labour demand (Chart 9).

An increase in foreign-born workers has driven most of the employment increase since December 2019 (Chart 10). The slower increases since mid-2024 reflects slower growth in foreign born workers.

Therefore, the risk is that an NFP slowdown could cause a tighter labour market and faster wage growth, the pattern prevailing since mid-2024 (Charts 11 and 12). By contrast with a demand-driven decrease in NFP, a supply-driven decrease would likely not see Fed cuts because of inflation risks.

Market Consequences

I still expect no Fed cuts in 2025, against market consensus for two cuts.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)