Labor Market Remains Strong Even as Other Indicators Weaken and the Fed Continues Aggressive Tightening Pace

Key Takeaways:

• At its November 1-2 meeting, the Federal Open Market Committee (FOMC) voted unanimously to raise the federal funds rate by 75 basis points to a target range of 3.75-4.0 percent, the fourth consecutive 75-basis point hike. The FOMC statement noted that ongoing rate increases are likely. In his press conference, Chairman Powell stated the terminal federal funds rate would likely end up being higher than the 4.6 percent shown in the September Summary of Economic Projections (SEP) and left the door open for either a 50- or 75-basis point hike in December. . 
• Nonfarm payroll employmentrose by 261,000 in October, a slight slowdown from the upwardly revised 315,000 in September, according to the Bureau of Labor Statistics (BLS). Job gains were broad-based; the health care industry led major sectors with 53,000 jobs added. The unemployment rate moved up two-tenths to 3.7 percent, due in part to a one-tenth decline in the labor force participation rate, which now sits at 62.2 percent. Average hourly earnings increased 0.4 percent over the month, an acceleration of one-tenth from the previous two months, and increased 4.7 percent annually, a deceleration of three-tenths compared to September.
• The Job Openings and Labor Turnover Survey (JOLTS)showed job openings rose by 437,000 to 10.7 million in September, reversing roughly half of August’s decline in openings, according to the BLS. Quits declined by 123,000 to 4.1 million, a still-elevated total compared to the pre-pandemic period.
• Nonfarm business productivity increased 0.3 percent annualized in Q3 2022, its first positive reading of the year but still well below average, according to the BLS. Unit labor costs rose 3.5 percent annualized, a sharp deceleration from the 8.9 percent reading in Q2 but still above the historical average.
• The ISM Manufacturing Index declined 0.7 points to 50.2 in October, its lowest level since May 2020. The headline index fell primarily due to a sharp 5.6-point drop in the supplier deliveries index; at 46.8, delivery timelines are getting shorter for the first time since 2015. Likely related, the non-seasonally adjusted prices paid index is also below 50 for the first time since the beginning of the pandemic after falling 5.1 points to 46.6. Positive categories included the new orders index, which rose 2.1 points to 49.2, and the production index, which was up 1.7 points to 52.3.
• The ISM Services Index declined 2.3 points to 54.4 in October, its lowest level since May 2020. Unlike the manufacturing index, both the non-seasonally adjusted supplier deliveries index and the prices paid index increased modestly, rising 2.3 and 2.0 points to 56.2 and 70.7, respectively. The business activity index dropped 3.4 points to 55.7, and the new orders index declined 4.1 points to 56.5.
• Light vehicle sales jumped 11.7 percent in October to a seasonally adjusted annualized rate of 15.3 million, the highest level since January, according to Autodata. However, some of the boost was likely due to abnormal seasonal adjustment patterns.
• Private residential construction was flat in September, ending a streak of three consecutive declines, according to the Census Bureau. Single-family construction spending fell 2.6 percent, while multifamily construction was up a modest 0.3 percent. Spending on improvements rose 2.9 percent.

Forecast Impact:

The economy continued to add jobs at a strong clip in October, largely in line with our forecast. While job growth remains strong, labor tends to be a lagging indicator of the general health of the economy (i.e., before past recessions, it was common for the economy to continue to add jobs even as signs of a slowdown were present elsewhere). Therefore, while we do expect job gains to slow through the end of the year, we forecast that the economy will not begin losing jobs on net until next year. Still, September job openings surprised to the upside and the quits rate remained elevated, largely dispelling the idea that labor supply and demand are returning to normal historical levels. While robust labor demand remains good news for workers, given both the abysmal productivity growth seen this year, as well as the ongoing imbalance with labor supply, wage growth continues to run above levels that are consistent with 2 percent inflation. We believe this is likely partially responsible for why the FOMC now believes the terminal federal funds rate will need to be higher than they had previously projected.

While nominal wage growth has been only been one of many components of inflation pressures to date, it historically is a more persistent source. The divergence between the ISM services and manufacturing indices suggest that services inflation may persist even if pressures ease elsewhere. Encouragingly, the manufacturing report suggests goods prices should begin to see outright declines in coming months and weakening demand has significantly improved supply chain issues. However, the upward movement in the services prices paid and supplier deliveries indices shows that this dynamic has not spread across all sectors of the economy. On balance, we believe the two indices are supportive of our view that the economy is largely stagnating, with services outperforming goods industries, and that inflation will slow but remain elevated. .

Nathaniel Drake
Economic and Strategic Research Group
November 4, 2022

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