FAB - Labor Markets Are Softening And It's Not A Positive
Summary
- The latest release of the Employment Cost Index shows decelerating wage pressures, particularly in sectors that were expected to cause ongoing problems.
- It is now obvious that there will be no wage-price spiral, which switches investor attention from inflation to the strength of the economy.
- While the housing sector remains robust, there are growing signs of pressure on consuming spending which will be reinforced by weak wage growth.
The latest release of the Employment Cost Index points towards a labor market that is rapidly cooling, extinguishing any thoughts of a wage-price spiral. This is supportive of lower inflation going forward and a normalization of Fed policy, but also increases the probability of a large fall in consuming spending at some point in the next 12-18 months. Investors must balance the prospects of lower discount rates with deteriorating economic prospects, with the latter likely to become increasingly important going forward.
Softening wage growth may surprise some, who continue to believe the labor market is tight based on the large number of job openings and the low unemployment rate. These are both flawed measures though, and are far less indicative than the number of hires and the quit rate.
Figure 1: Job Openings and Unemployment Rate (source: Created by author using data from The Federal Reserve)
Figure 2: Hires and Quits (source: Created by author using data from The Federal Reserve)
Not only is wage growth returning to a fairly normal range, but wage pressure in industries that have been causing the most concern has also eased significantly. Given this development, it now seems unlikely that any sort of demand driven inflation will be realized.
Figure 3: Employment Cost Index by Industry - 3 Month Change (source: Created by author using data from BLS)
Figure 4: Aggregate Wage Growth (source: Created by author using data from The Federal Reserve)
Industries that have seen a rapid normalization of employment cost growth are also generally tied to consumer spending (retail trade, accommodation and food services, leisure and hospitality). Given the importance of consumer spending and housing to the economy, any signs of weakness in these areas should be interpreted negatively.
Figure 5: Employment Cost Index Grouped by Exposure - 3 Month Change (source: Created by author using data from BLS)
Not only is wage pressure easing in these areas, but aggregate hours worked has also begun to level off / decline. While housing and consumer spending are still holding up fairly well, the labor market is suggesting that they have weakened or are expected to weaken.
Figure 6: Aggregate Weekly Hours (source: Created by author using data from The Federal Reserve)
The rapid rise in interest rates has really crushed upstream activity in the housing market. The backlog of housing under construction from COVID is currently buffering employment in the construction industry, but absent a rapid decline in mortgage rates it would seem employment will get hit at some stage.
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Labor Markets Are Softening And It's Not A Positive