Labor market stresses amid “substantial progress” toward the Fed’s employment mandate

Link to PDF: Labor market stresses amid “substantial progress” toward the Fed’s employment mandate

Note: use ‘Link to PDF’ to view the full report and updated labor market dashboard charts. Inflation Watch, the companion piece to this report covering inflationary conditions will be published in the coming days.

*This report updates our enhanced labor market dashboard that builds upon the dashboard of 12 indicators originally developed by former Federal Reserve Chair Janet Yellen.  It helps to assess the labor market recovery from the pandemic and progress toward the Fed’s employment objective established in its new strategic plan (“Updated expanded labor market dashboard indicates ‘substantial progress’ has been made toward the Fed’s employment mandate”, August 12, 2021).

*We conclude that 1) labor market indicators have recovered significantly, and “substantial progress” has been made toward the Fed’s maximum inclusive employment mandate; and 2) labor market shortages and other stresses have emerged that have constrained even faster recovery in labor markets and the economy.  We anticipate that those stresses may persist longer than many observers expect.

*Table 1 summarizes Bureau of Labor Statistics data on the Spring 2020 pandemic collapse and sharp rebound in labor market data.  The recovery of most key labor market data has far exceeded all but the most optimistic forecasts.  As an overall assessment, labor market conditions are currently similar with those that existed during mature stages of prior economic expansions. 

*Establishment payrolls have recovered 78.8% of their pandemic decline.  The number of unemployed has fallen 89% of its pandemic surge and the unemployment rate has recovered 88.5% of its temporary spike.  The labor force participation rate recovery has been less—43.8%--but establishment payrolls have recovered 78.8% of their earlier decline, resulting in a 75.5% recovery in the employment-to-population ratio.  U-6, the broadest measure of underemployment that includes marginally attached and part time workers, has retraced 90% of its pandemic spike.  The unemployment rates of black people and Hispanic or Latino people have recovered 83% and 86.3%, respectively, from their pandemic spikes.

Table 1: Select Labor Market Indicators

*There are significant stresses in labor markets stemming from strong demand, supply shortages, turbulence stemming from heightened job mobility and quickly evolving preferences by people, and government fiscal policies that are influencing labor supply.  The BLS’s just-released JOLTS report highlights the strong demand and insufficient supply of labor:  job openings in August were 10.4 million, second highest ever behind July’s 11.1 million.  New hires were 6.3 million, down from the 6.7 million spike in July.  The 4.1 million gap between openings and hires reflects the labor shortages (Chart 2).  

Chart 2: JOLTS Job Openings vs. Hires (millions)

*The strong demand for labor and insufficient supply is constraining the productive capacities of businesses and pushing up wages and operating costs.  The BLS reports that average hourly earnings have risen 4.6% yr/yr and at a 6% annualized pace in the last six months. These increases have been exceeded by inflation pushing down real wages.  Businesses face significant stresses.  Those stresses are in production, distribution and costs, while product demand remains healthy. Industrial production in September fell below its pre-pandemic level.

*The National Federation of Independent Businesses (NFIB) that includes several million small businesses conducts a survey of its members and among other questions asks them to identify among ten items the single most important problem they face.  In the most recent survey, 28% of NFIB respondents identified “quality of labor” (a record high going back over three decades), 10% identified “costs of labor” (near record high), and 13% identified “inflation”, near a record high (Chart 3).  A near record low of only 4% identified “poor sales” as their single most important problem.  Medium and large-sized businesses are expressing the same concerns.  This underlines the observation that aggregate demand in the economy is strong, while labor shortages and stresses are constraining hiring and economic activity.

Chart 3: NFIB Single Most Important Problem: Percent Reporting Quality of Labor

*The Fed has been very slow to come around to acknowledge that labor markets have made “substantial progress” toward its maximum inclusive employment mandate, its subjective requirement for announcing that it will begin to taper its asset purchases.  While the Fed has not established any numeric targets for its maximum inclusive employment objective, its benchmark seems to be the labor market conditions that existed just before the onset of the pandemic.  It is noteworthy that these conditions were achieved at the end of the longest economic expansion in U.S. history. 

*The expanded labor market dashboard shown below clearly indicates that substantial progress has been made and current conditions are similar to mature stages of prior expansions, and that supply shortages are constraining the pace of recovery, while demand is strong and not the problem.  The Fed forecasts further significant improvement in labor markets.  In its September Summary of Economic Projections, the median FOMC member forecast is that the unemployment rate will fall to 3.8% by year-end 2022 and to 3.5% by year-end 2023 and remain at 3.5% in 2024.  These are well below the Fed’s estimates of longer-run full employment. 

*At the same time, the Fed has acknowledged that the higher inflation has met its required make up strategy following the prior years of low inflation.   Accordingly, the criteria are in place for the Fed to announce that it will taper its asset purchases.  An announcement on the near-term horizon is consistent with our earlier expectation (“Strong U.S. Growth, Inflation and the Fed’s Challenges”, February 11, 2021).

Link to PDF: Labor market stresses amid “substantial progress” toward the Fed’s employment mandate

Mickey Levy, mickey.levy@berenberg-us.com

Mahmoud Abu Ghzalah, mahmoud.abughzalah@berenberg-us.com

© 2021 Berenberg Capital Markets, LLC, Member FINRA and SPIC

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