TIP - November Employment Data Do Not Support Fed Rate Cut Expectations

2023-12-08 12:45:23 ET

Summary

• The Employment Situation Report for November 2023 was published, providing important labor market data from both the Establishment and Household Surveys.
• The data indicate labor markets remained very tight and may have tightened further -- contrary to expectations.
• Nonfarm jobs grew by +199K, slightly exceeding economists' forecasts. The unemployment rate declined from 3.9% to 3.7%, again indicating tighter-than-expected labor market conditions.
• The data in the Employment report are not supportive of current market expectations of Fed rate cuts.

The Employment Situation Report ((ESR)), corresponding to labor market activity during the month of November 2023, was published by the Bureau of Labor Statistics, or BLS, on Friday, December 8, 2023, at 8:30 AM EST. This report makes available an extraordinary amount of important labor market data derived from two separate surveys: The Establishment Survey and the Household Survey.

In this article, we will walk readers through a detailed breakdown of the most important employment statistics derived from both surveys. We will also discuss the likely implication of the report for bond and equity markets.

Summary Data and Analysis

We begin our examination with summary data and analytics which we highlight in Figure 1. We recommend that readers pay particular attention to the percent rank of Month-on-Month (MoM) growth, MoM acceleration, and the surprises relative to forecasts.

Figure 1: Change, Acceleration, Expectations, and Surprise

Through analysis of payroll data (obtained via the Establishment Survey), the BLS estimated that there were a total of 157,087 nonfarm jobs in the U.S. economy in the month of November. This represents a Month-on-Month (MoM) growth of 199K jobs compared to the comparable (revised) figure for the previous month. This MoM rate of change ranks in the 53rd percentile of historical data. Compared to the MoM rate of change (revised) for the previous month (0.10%), the MoM rate of change for October represents an acceleration 0f 0.03%. Finally – and perhaps most importantly from the perspective of interpreting the reaction of financial markets to this data – the reported MoM rate of change for November was slightly greater than the median forecast of professional economists.

Figure 1 provides similar analysis for Average Hourly Earnings, Average Hours Worked (Weekly) and the Unemployment Rate.

The decline in the unemployment rate -- particularly relative to expectations -- was notable.

Establishment Survey

This section of our report will be devoted to analysis of data derived from the Establishment Survey. The first section tracks the rates of change of nonfarm payrolls over several time frames, broken down by industry groups. The second section presents a decomposition analysis of the contributions of various industry groups to the overall MoM change in nonfarm payrolls. The third subsection will review changes in average weekly hours and the fourth subsection will analyze changes in Average Hourly Earnings.

Analysis of Annualized Growth of Major Components of NFP Over Various Time Periods

In this section we break down Nonfarm Payrolls (NFP) by major industry groups, scrutinizing their annualized growth rates over various time frames (1m, 3m and 12m). The purpose of this analysis is two-fold. Our first purpose is to identify which components of NFP are exhibiting rates of change that are greater or less than than the overall aggregates. Our second purpose is to determine whether, and to what extent, the rates of change of the various components are accelerating or decelerating over various time frames. Nonfarm Payroll figures are displayed in thousands.

Figure 2: Annualized Growth Rates of Key Components

It is important to note that in the past 3-month period, growth in nonfarm payrolls has decelerated very significantly compared to the 12-month growth rate. Indeed, the growth rate of private nonfarm payrolls has fallen below the historical median (37.13 percentile).

Only strong increases in government payrolls have kept the overall NFP data strong in the past 3-month and 12-month periods. The pattern was again repeated during the past month, with private payroll growth well below the median while government payroll growth was above the median.

Indeed, private payroll growth actually surprised to the downside relative to expectations.

It is also important to note that manufacturing sector growth this month was very strong due to the end of the auto strike. Growth in most other economically-sensitive sectors was quite weak.

Analysis of the growth rates of the various components of NFP suggests a somewhat weaker economy than the headline figures might suggest.

Contributions to Change and Acceleration of NFP: Decomposition Analysis

In this section our analysis is focused on identifying the contributions of various industry groups to the MoM Change and MoM Acceleration of the aggregate Nonfarm Payrolls statistic. Nonfarm Payroll figures are displayed in thousands.

Figure 3: Contributions to Change and Acceleration Attributable to Major Components to NFP

The MoM rate of percent change of overall NFP was 0.13%, with the private sector contributing 0.10% and government contributing 0.03% to that overall figure. Within private sector payrolls, goods-producing industries contributed 0.02% while services producing industries contributed 0.08%.

Overall, the following three components made the largest positive contributions to the rate of change in NFP: Private education and health services (0.06%), Leisure and hospitality (0.03%) and Local government (0.02%). The largest negative contributors were Trade, transportation, and utilities (-0.02%), Professional and business services (-0.01%) and Mining and logging (-0.001%).

Average Weekly Hours Worked

In this section, we analyze changes in average weekly hours worked, according to payroll data. This indicator is important for two reasons. First, it is an important indicator of labor demand. Second, it has a significant impact on the earned income component of overall personal income in the US economy. Readers may want to pay particular attention to average weekly hours worked in manufacturing industries as this is considered to be a leading indicator of economic activity.

Figure 4: Contributions to Change and Acceleration Attributable to Major Components of Average Hours Worked

Growth in average hours worked was quite strong this past month (87.2 percentile), but only about average on a 3-month basis. When looking at the 3-month data, weakness in manufacturing (20.5 percentile) – a leading indicator of economic activity – has been notable. Of particular note is the weakness in Durable Goods manufacturing on a 1-month (18.9 percentile), 3-month (6.2 percentile) and 12-month (26.4 percentile) basis.

Average Hourly Earnings

In this section, we analyze Average Hourly Earnings ((AHE)). This is a very important statistic for two reasons. First, wages impact personal income, and therefore have a significant impact on aggregate demand in the economy. Second, wage data serve as an indicator of actual and/or potential wage pressures on U.S. businesses. The rate of change in hourly earnings can have significant effects on business profitability and/or consumer prices.

Figure 5: Contributions to Change and Acceleration Attributable to Major Components of Average Hourly Earnings

Average Hourly Earnings rose by 0.35% MoM, which was only slightly higher than the median forecast. The BLS rounds the AHE figures to one decimal point, which makes the headline number look stronger than it was, when compared to the figure rounded to two decimal points.

Household Survey

This section of this report will be devoted to examining changes in the Household Survey. We will begin by analyzing the annualized growth rates of each unemployment rate (U-1 to U-6) and then we follow this up with an attribution analysis that will identify the primary drivers of the change in unemployment rate.

Alternative Measures of Labor Underutilization

In Figure 6, we scrutinize the annualized growth rates of various measures of underemployment and unemployment in the U.S., over various time frames (1m, 3m and 12m). The “official” rate of unemployment is the U-3 figure, while the other measures provide alternative measures of underemployment.. The purpose of this analysis is two-fold. Our first purpose is to identify which, if any, alternative measures of unemployment are growing at a faster or slower rate than the official unemployment rate (U-3). Our second purpose is to determine whether, and to what extent, growth rates are accelerating or decelerating over various time frames.

Figure 6: Measures of Unemployment Rate (U-1 to U-6)

The first thing that should be noted is that the percentile ranks of the most important measures of labor underutilization are very low by historical standards, indicating very high levels of tightness in the US labor market.

Labor underutilization rates declined across the board during the past month – a surprise relative to expectations.

Divergences in the behavior of the various measures of labor underutilization can sometimes provide signals about the strength of the labor market. However, over the past year, there have been no major divergences in the change in U-3 unemployment rate (official unemployment rate) and the other alternative measures of labor underutilization.

The remainder of the Household Survey section of the report will be devoted to the analysis of the U-3 measure of underutilization, which is the “official” unemployment rate.

Major Components of Unemployment Rate: Decomposition Analysis

In Figure 7, we show a decomposition analysis of the Unemployment Rate, highlighting the contributions of its two primary determinants: Unemployment Level and Participation Rate. We further break down the participation rate into changes in participation that were caused by changes in the working-age population and changes in the percentage of the working-age population that chooses to participate in the labor force.

Figure 7: Contribution of the Primary Components of the Unemployment Rate

Note: Due to the mathematical properties of ratio statistics, the estimates of contributions of specific components to the change in the unemployment rate and participation rate (both of which are ratios) are not exact, but represent very close approximations.

As can be seen above, almost all of the decline in the unemployment rate this past month can be attributed to the decrease in the number of unemployed persons (level), as opposed to changes in the participation rate. This indication of labor market strengthening represents somewhat of a surprise relative to expectations.

Implications for the U.S. Economy

In this section we review the implications of the data in the just-released Employment Situation Report for our outlook for the U.S. economy.

Background

Before discussing the impact of the ESR data on the economic outlook, as background, it is important to understand where things stood prior to the publication of the report.

The first and most important background fact is the extraordinary tightness in labor markets in the U.S. For example, Fed officials have clearly indicated that they do not believe that the sort of tight labor market conditions that have characterized the U.S. economy in the past few months are consistent with consumer price inflation falling (and stabilizing) at the Fed's target rate of 2.0%. Therefore, the tightness of the Fed’s monetary policy needs to be reflect the tightness in the labor market. However, the rate of change in labor conditions is critical. If conditions in the labor market are tight but slightly less tight (assuming the current level of policy was already appropriate for the extant level of labor market tightness), the Fed might be able to “pause” tightening measures or even “ease” policy.

First, let’s review the evolution of the unemployment rate. The unemployment rate currently stands at 3.7% versus the Non-Accelerating Inflation Rate of Unemployment ((NAIRU)) (as measured by the CBO), of 4.4% (-0.7% below full employment). After several months of rising unemployment, unemployment actually fell during the past month. By this measure, labor market conditions remain extraordinarily tight and may have even tightened in November.

Second, let’s review the evolution of the growth rate in nonfarm payrolls. Private NFP has grown at an average rate of 204,000 per month in the past three months. This is above our estimated “breakeven” level of private nonfarm payroll growth in the U.S. of approximately 175,000 (the “breakeven level of payroll growth that which we estimate would keep the unemployment rate unchanged; this includes growth of the labor force and some level of increase in labor force participation). The implication is that, according to NFP data, labor market conditions are tightening.

Third, let’s review the evolution of average hourly earnings. Wage growth that exceeds the Fed’s inflation target of 2.0% by a margin of 1.5% (the long-term growth rate of labor productivity) – i.e. wage growth in excess of 3.5% – will tend to place upwards pressure on consumer price inflation and place downward pressure on corporate profits. In the past 3 months, average hourly earnings growth (3.35% annualized) has been below this benchmark of 3.5%. However, the rate of change in this past month (4.32% annualized) was above this benchmark of 3.5%.

In sum, taking all of the above indicators into account, U.S. labor market conditions remain very tight, and may even be tightening. On this basis – contrary to market expectations – there would appear to be very little reason for the Fed to consider any policy easing.

Did This Report Change the Overall Economic Outlook?

The question we now seek to answer is: Do the data released in this Employment Situation Report change the economic outlook? Will Fed and/or financial market participants change the way that they have been evaluating the state and/or trajectory of labor market conditions?

The data in the ESR have not changed our own medium or short term outlooks for the US economy. We expect the economy to slow, and leading employment indicators provide support for this view.

In terms of how Fed officials are likely to react to this report, we see little to support the notion that the Fed should be considering an easing of their monetary policy. In our view, it would be a mistake for the Fed to prematurely soften its policies or communications, particularly at a time when labor market conditions remain very tight – and in fact, appear to be tightening further.

In terms of the interpretation of markets, the data seem to support market expectations of a “soft landing.”

Implications for Financial Markets

Due to ADP and other data, markets came into this report leaning in the direction of expecting some weakness in the employment data. The headline data did not really bear this out. The immediate reaction in financial markets was for bond yields to rise. However, roughly half of the initial rise in bond yields was retraced. This may be due to the fact that the private payrolls data was actually fairly soft. The S&P 500 (SP500) has rallied modestly, probably due to relief that the numbers were not significantly different from expectations – particularly when looking at the internals. Indeed, the numbers seem to support the notion of a “soft landing” narrative.

The employment numbers suggest somewhat of a “goldilocks” scenario of moderate economic growth. This is supportive of equity markets.

However, in terms of bond prices, it is our view that interest rate markets have gotten way out ahead of themselves in terms of expectations of rate cuts. Prior to today, the futures market was pricing a Fed rate cut in March of 2024 and a total of 125 basis points of cuts in 2024. We do not feel that the data in the Employment Report supports such expectations, whatsoever. Indeed, unless substantial economic weakness becomes manifest in other data in coming days and weeks bond yields may continue to bounce higher. This is particularly true due to deeply overbought short-term technical conditions in bond markets.

Concluding Thoughts

At our Investing Group, we have been bullish on long-term Treasury instruments, due to our expectations of a significant slow-down in the economy. However, tactically, we think some recent gains in the Treasury market could be retraced, as expectations of Fed rate cuts have become far too optimistic, in our view. Additionally, our view is that the VIX is underpricing risk, leaving the equity market exposed to a sharp correction in coming weeks and months.

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