VTI - August Jobs Report Preview: It's All About Labor Strikes And Unionization Now

2023-08-29 08:45:24 ET

Summary

• Core PCE inflation has decreased to 4.1% in June 2023, but is expected to increase to 4.2% in July.
• The labor market labor shortage is driving inflation, with calls for unionization and strikes posing a threat to price stability.
• The August labor report is expected to show slowing payrolls growth, a stable unemployment rate, and elevated wage growth.

The macro context

The core PCE, which is the Fed's preferred inflation measure, has decreased to 4.1% in June 2023 from the inflationary spike peak of 5.2% in September 2022. The Fed's target is 2%, which means currently inflation is double the Fed's target. Even more worrisome, the core PCE is expected to increase to 4.2% in July. The PCE inflation reading will be released on Thursday, August 31.

The Fed has been increasing interest rates since March 2022 to fight the inflationary spike, and this has been one of the most aggressive monetary policy tightening cycles ever - the Federal Funds rate increased from near 0% to 5.32%. Yet inflation remains stubbornly sticky at a very high level.

Thus, the Fed might be forced to continue hiking interest rates and keep the interest rates at the restrictive level for longer - which significantly increases the risk of overtightening and the resulting hard landing, or a deep and long recession.

The key variable that's driving inflation is the labor market. More specifically, there is a serious labor shortage in the U.S., which is pushing the wages higher, and thus pushing the consumption-sensitive services inflation higher.

The Bank of International Settlements, or BIS, which acts as a bank of central banks globally, has warned that the "self-sustaining wage-price dynamics could tip the disinflation process off course":

While nominal wage growth has not been exceptionally strong so far, this should not provide too much comfort. Wage adjustments are still influenced by the lingering effects of the norms prevalent in the low-inflation regime, but this could change quickly. The inflation surge has severely eroded the purchasing power of households, even more than in past disinflation episodes. Some catch-up is on the cards, particularly given the strength of labour markets. While labour's bargaining power declined significantly over the years of low inflation, recent strikes and calls for unionisation suggest that the environment is evolving . In the euro area, for instance, negotiated wage growth has been on the rise and is now at its highest level since the inception of the common currency. And while multi-year wage contracts generally make the adjustment lags for wages considerably longer than for prices, contract length may shorten in response to higher and more persistent inflation. What's more, the pass-through from prices to wages has been somewhat higher when labor markets have been tight.

The BIS report specifically warns that the calls for unionization and the labor strikes could be the major problem going forward in restoring the price stability at the 2% level.

The summer of 2023 has been the summer of strikes. Just recently , UPS and Teamsters have negotiated a new contract which will pay the UPS drivers up to 170K per year. The United Auto Workers are getting ready for a strike after the current contract expires on September 15th. number The UAW is requesting "40% general pay raises over four years, an end to wage tiers, restoration of pensions for new hires, cost-of-living increases, and more benefits."

The chart below shows the number of workers on strike each year. Note, during the inflationary 1970s, there were 2-3M workers on strike a year. That's the inflationary danger that BIS is warning about, and it seems like we're getting there.

The August labor report

The BLS will release the labor report for August on Friday. These are the consensus market expectations:

The market consensus expectation is that the payrolls will continue to slow down to 170K from 187K in July. On year-over-year basis, the payrolls rose by 2.2% in July, and the trend is decelerating. The chart below shows that the payrolls are a lagging indicator, the annual growth in payrolls has been positive as each prior recession has been officially called - it's the decelerating growth in the payrolls that signals a recession, and that's what we currently have.

The unemployment rate is expected to stay at 3.5%, and this reflects the labor shortage, especially when combined with the JOLT job openings. Specifically, the U.S. has a significant shortage of health and education workers, which accounts for the majority of job openings, and this is not going to improve due to demographics. There are reports of teacher pay rises , and some ISDs are even sponsoring H1B visas to import teachers.

Which brings the key data point - the hourly wage growth. The market consensus is 0.3% mom wage growth, down from 0.4% in July, and an annual 4.4% wage growth, unchanged from July. As the chart below shows, wage growth has been at 4.4% since January - no improvement in 2023. Given the trend on labor strikes and unionization, the wage growth is likely to remain elevated, and possibly increase back above 5% as the data starts reflecting the outcomes of strikes, like the UPS, UWA, Hollywood, etc.

The average weekly hours are expected to stay unchanged at 34.3h per week. This data point is actually considered to be a leading indicator, so the downtrend in the weekly hours supports the thesis that the labor market is weakening.

Implications

First, the labor market is weakening. The annual growth in payrolls is decelerating, as well as the trend in weekly hours worked. However, the labor shortage still persists, which is supporting the rise in unionization, and the strikes.

This environment points to stagflation - weakening economy and still elevated inflation, well above the 2% target. The Fed is now data dependent - and the wage growth data is unlikely to "look good" any time soon, which is likely to force the Fed to keep hiking the interest rates.

The bond market is starting to price another 25bpt hike in November with about 60% probability, and no additional hikes in September. The Fed does not like to surprise the market, but it will be very difficult to pause in September, given the strikes and their effect on wage growth, especially is the inflation data for August comes "hot" as expected.

The stock market ( SP500 ) is still detached from reality, trading at the P/E ratio of 20, which assumes an above average growth and low inflation. The current 5% dip is beginning a much deeper and longer correction, as the stagflationary environment gets priced in.

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