Labor Market Remains Strong as the Fed Increases Pace of Tightening

Key Takeaways:

• At its May 3-4 meeting, the Federal Open Market Committee (FOMC) voted to raise the target rate for the federal funds rate by 50 basis points to 0.75-1.0 percent. Additionally, the committee announced that they will begin running off the Fed’s balance sheet in June, starting with a $30 billion cap for Treasury securities and a $17.5 billion cap for MBS, though these will increase to $60 billion and $35 billion, respectively, in September. In his press conference, Chairman Powell stated that 50-basis point hikes will be on the table for the “next couple of meetings” but largely ruled out larger 75-basis point hikes.
• Nonfarm payroll employment increased by 428,000 in April, though the February and March numbers were revised downward by a combined 39,000, the first downward revision since June 2021, according to the Bureau of Labor Statistics (BLS). The unemployment rate was unchanged at 3.6 percent, but the labor force participation rate fell two-tenths to 62.2 percent, its first decline since May 2021. Job gains were broad-based, with leisure and hospitality adding 78,000 workers, manufacturing up 55,000, and transportation and warehousing increasing by 52,000. Average hourly earnings for all private employees were up 0.3 percent in April and 5.5 percent on an annual basis.
• The Job Openings and Labor Turnover Survey (JOLTS) showed a broad-based increase in job openings, which rose by 205,000 to 11.5 million in March, a new series record, according to the BLS. The number of quits also hit a new record, increasing 3.5 percent to 4.5 million. In March, the ratio of unemployed persons to the number of job openings was 1.9, the highest level on record.
• Nonfarm business productivity declined 7.5 percent annualized in Q1 2022, the sharpest one-quarter decline since 1947, according to the BLS. On an annualized basis, real output was down 2.4 percent while hours worked increased 5.5 percent. The unit labor cost jumped 11.6 percent annualized, the largest increase since 2020 Q4.
• The ISM Manufacturing Index declined 1.7 points to 55.4 in April, its lowest level since September 2020, though still above the expansionary threshold of 50. The decline was largely due to a 5.4-point drop in the employment index, which is now at 50.9. Both the new orders index and the production index also fell.
• The ISM Services Index declined 1.2 points to 57.1 in April. Both the new orders index and employment index were down sharply, falling 5.5 points to 54.6 and 4.5 points to 49.5, respectively. Partially offsetting these drops was a 3.6-point increase in the business activities index to 59.1. The prices index increased 0.8 points to 84.6, a series record.
• Factory orders increased 2.2 percent in March and were upwardly revised in February by six-tenths to a 0.1 percent gain, meaning orders have increased for 11 consecutive months, according to the Census Bureau. Excluding transportation, orders were up 2.5 percent. Nondurable goods orders increased 3.2 percent.
• Light vehicle sales increased 7.5 percent to a seasonally adjusted annualized rate of 14.6 million in April, the highest level since January, according to Autodata.

Forecast Impact:

April’s employment report was modestly above our expectations. Further, the JOLTS data continues to tell a story of robust labor demand: Job openings hit a new record and there were nearly two openings per unemployed person in March. Ongoing labor market strength is a major reason we continue to believe near-term growth will resume despite a negative GDP print for Q1. However, ongoing strong wage growth exceeding the rate of productivity growth, which plummeted in Q1 (though this measure is volatile), is also a key contributor to current inflation pressures. On balance, these reports are unlikely to substantially change our near-term growth or labor market outlooks as they were near our current expectations.

The Fed acted in line with our expectations at their May meeting, and we continue to expect 50-basis point hikes to the federal funds rate in their next two meetings. The elevated job openings and quits rates imply there is some room for the Fed to tighten monetary policy without meaningfully impacting the unemployment rate, but we are skeptical that this would be sufficient to bring wage growth to a level that is consistent with the Fed’s two-percent inflation target.

Both ISM indices pointed to some near-term slowing in output in April. Still, both indices remain generally at or above 2019 levels when GDP growth averaged 2.3 percent, so we continue to view the ISM surveys as consistent with our positive near-term growth outlook, which forecasts a slower pace of expansion in 2022. Therefore, we view the level of the ISM surveys as more important than the direction and will not change our growth outlook based on the April declines.

Nathaniel Drake
Economic and Strategic Research Group
May 6, 2022

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