- December job growth was strong, but not too strong; adding 223,000 jobs in December.
- Historically, employment has usually grown at a 1-2.5% annualized pace during economic expansions. December's gain is equivalent to a 1.75% pace of growth, so right in the middle of that historic range.
- The service economy may be weakening. The hiring plans for this segment indicated that firms plan to cut head counts on average, and the new orders segment was the weakest read since May 2020.
- The chances of a “soft landing” are rising. We have seen several good signs for the soft landing scenario in the last couple of months.
The December employment report released last week gave markets some real reasons for optimism. Job growth was strong, but not too strong. In addition, wage gains were positive but slow enough to suggest inflation could be coming down. Here are our views on this report and how it might impact your portfolio looking ahead.
Hiring is Slowing, But Demand for Workers Still Strong
Ideally, the economy would add jobs at a robust pace but not so strong as to create inflation. There is some hope that the pace of job gains the last few months have hit this balance. In the first half of the year, job growth averaged 444,000 per month. In the last three months, that total averaged only 247,000 per month, including 223,000 in December.
Historically, employment has usually grown at a 1-2.5% annualized pace during economic expansions. December's gain is equivalent to a 1.75% pace of growth, so right in the middle of that historic range. This tells us that if history is a guide, job growth around the current pace is sustainable without necessarily causing inflation.
Wage Growth Not as Fast as Feared
One way we can tell if a given level of job gains is sustainable is to look at wage growth. Of course, higher wages aren't necessarily a bad thing, but the Federal Reserve knows that inflation probably won't subside without slowing wage growth. The reason is simple: higher wages fuel more spending, and right now, the level of spending is outpacing the economy's ability to produce. So until spending is more balanced with production, we'll keep having an inflation problem.
Last month's wage growth surprised to the upside, which led to stocks plunging on the day of the jobs report. There was double good news on wages out of this month's report. First, there was a revision to last month's figures. It is now estimated that hourly wages only grew by 0.4% as opposed to the 0.6% first estimated. Second, wage growth slowed even more this month, coming in at just 0.3%.
It is clear now that wage growth is slowing significantly. As mentioned above, average hourly earnings have slowed somewhat, but average weekly earnings (which also includes how many hours employees worked) are slowing even more. The chart below shows the average wage using both measures---the first nine months of 2022 and the most recent three months---comparing both to the pre-COVID trend.
Service Economy May be Weakening
On the same day as the employment report, the Institute for Supply Management produced its sentiment survey for Services firms. In this case, "services" means any company, not in the manufacturing business. This closely-watched survey asks a number of forward-looking questions of executives, measuring things like expected new business, and hiring plans.
The survey results were surprisingly weak. The hiring plans segment indicated that firms plan to cut headcounts on average, and the new orders segment was the weakest read since May 2020.
While this may sound like bad news, stocks climbed higher after this report was released. This is really for two related reasons. First, markets believe the sooner the Fed can stop hiking rates, the less the economy will suffer, i.e., some weakness now might save us from even more pain later. Second, we have already seen clear signs that consumers are spending less on physical goods. This has resulted in prices for goods declining in the last two CPI reports. If services spending also weakens, and prices also slow down in that part of the economy, that would all but ensure that inflation will continue to subside.
The Chances of a Soft Landing are Rising
For months, we've discussed the possibility of a "soft" vs. a "hard" landing for the economy. The "soft" landing would be where inflation reverts to around 2% without unemployment rising by much. The "hard" landing is where it takes a full-on recession to get inflation under control.
We have seen several good signs for the soft landing scenario in the last couple of months. The most important is that actual inflation has declined a bit. Other signs, including slower hiring and wage growth and perhaps some weakness in the service sector, are also helpful signs. They indicate that the Fed is making progress on inflation now, which could mean they don't need to damage the economy further. That would be precisely how a soft landing could be achieved.
We don't want to sound overly optimistic. For example, slower job growth could become a trend and weaken further in 2023. That is certainly a possibility for which we have prepared. That being said, there is clearly more reason for optimism now than six months ago. In the coming months, we will closely watch wage growth, household spending, and ultimately inflation to see if this soft landing scenario becomes all the more likely.
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