NFP Review: Rising Unemployment Does Not Signal Recession

Summary

• June NFPs were higher than expected but May’s were revised lower.
• Wage growth was unchanged MoM but slowed YoY.
• Unemployment rose further but I think this does not announce recession as:
  • Employment growth has been resilient.
  • Insured unemployment remains flat.
  • Distribution of unemployment spells is inconsistent with a recession.
• Rather, the increase in unemployment reflects normalization from very low levels as well as inflows of migrant workers.

Market Implications

• I still expect no 2024 cut, against the market pricing two by end-year.

Another Positive NFP Surprise

In this note, I review the June NFP and argue the steady increase in the unemployment rate is not announcing recession.

As Sam’s model predicted, June NFPs surprised on the upside with 206,000 against 190,000 consensus and 218,000 (revised) in April (Chart 1). On a 6mma and 3mma basis, June NFP was roughly unchanged by contrast with previous, unrevised data showing an acceleration.

The household (HH) survey showed only a 116,000 increase in employment. The establishment/HH survey employment gap remained close to post-pandemic highs, which likely reflects undercounting of migrant workers.

Participation was roughly unchanged, with an increase in prime age participation offsetting a decrease in older worker participation (Chart 3).

Contrary to some expectations, wage growth did not accelerate MoM and slowed YoY (Chart 4). This is consistent with an immigration-driven increase in labour supply keeping a lid on wage growth.

That said, this is average wage, which the job gains distribution can skew. The Atlanta Fed no longer produces median wage estimates and the Q2 ECI, the Fed’s preferred measure of wage growth (because it takes into account wage distribution changes), will only be released on 31 July.

Sahm’s Rule to Give False Positive

Unemployment rose 10bp to 4.1%, and Sahm’s recession indicator rose to 43bp, close to the 50bp threshold indicating the economy is in recession. Should unemployment rise to 4.2% in July, Sahm’s recession indicator would hit the 50bp threshold.

Sahm’s rule says that when unemployment increases fast, the economy is in recession. This captures the much faster changes in unemployment on the upside than on the downside.

This time though, I believe the 50bp threshold for recession will be a false positive, largely because higher unemployment reflects labour market normalization following extreme policy easing and migrants taking longer to find jobs than native-born workers.

First and foremost, resilient employment growth has accompanied the rise in unemployment, which remains above pre-pandemic levels (Chart 5). The 2022-23 employment growth slowdown reflected earlier unsustainable employment growth, which was due to extreme policy easing.

By contrast, in the lead up to a recession, a slowdown in employment growth typically precedes the rise in unemployment, as employers prefer to cut down on new hires than fire existing workers.

Second, the insured unemployment rate has remained flat, by contrast with a recession when the insured unemployment rate rises (Chart 6). This shows the ongoing increase in unemployment reflects mainly workers who have not contributed long enough to be entitled to jobless benefits. For instance, new entrants to the workforce and/or undocumented migrants.

Third, the distribution of unemployment spells does not signal recession (Chart 7). Median unemployment duration is well below the mean because most workers experience only short unemployment spells (i.e., the distribution of spells is skewed to the left). The skew (average minus median, Chart 7) increases during a recession because of large inflows of newly unemployed workers. However, since Q1 2023 the average duration of spells has increased but their distribution has been roughly stable.

Lastly, the extreme policy easing during the pandemic has decreased unemployment to 3.4%. The last time unemployment was so low was in 1969. In the post-WWII period, unemployment has been below 3.4% only in the early 1950s. Therefore, the current increase is partly more labour market normalization than weakening.

Market Consequences

In line with my analysis, the Fed monetary policy report published on 5 July shows the Fed acknowledges the rising unemployment rate but is not concerned over labour market weakening. Rather, the Fed views ‘the balance between labor demand and supply’ as ‘similar to that in the period immediately before the pandemic, when the labor market was relatively tight but not overheated.’ Also, the Fed sees nominal wage growth as ‘above a pace consistent with 2 percent inflation over the longer term.’

This suggests rising unemployment alone is not enough to get the Fed to ease this year. I still expect no cut in 2024, against the market pricing two by December.

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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.

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(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.)