State of the labor market: Is it getting weaker or stronger?

The jobs market in the U.S. seems to be full of contradictions. On one hand, layoffs announcements from major companies seem to be coming every day. On the other hand, the Unemployment Rate is at its lowest level since 1968, and the most recent jobs report from the Department of Labor indicates the economy added over 500,000 new jobs. So which is it? Is the labor market weakening or getting stronger? Here are our thoughts on how to sort through these contradictions and how they may influence investment markets in the future.

Layoffs are on the rise

First of all, more companies are announcing layoffs. Six of the ten largest U.S. companies by market capitalization have announced layoffs within the last two quarters. According to executive outplacement firm Challenger, Gray & Christmas, companies have publicly announced over 223,000 layoffs in the last three months---the most since 2020---up from just 76,000 in the third quarter of 2022.

Layoffs have been especially acute in the technology industry. Just under half of the layoffs announcements were from tech firms. However, the uptick in job cuts plans has become increasingly pervasive. Of the 31 industry groups that the Challenger layoff report tracks, 27 have announced more job cuts in the last three months than they did in the prior three months. 

Why aren’t all these layoffs causing higher unemployment?

Surprisingly, all of these layoffs aren’t showing up in official macroeconomic statistics. As we mentioned in the intro, the Unemployment Rate hasn’t been this low in over 50 years. Similarly, initial applications for unemployment insurance are currently as low as they have ever been as a percentage of the labor force.

There could be a few reasons why these layoffs aren’t causing unemployment to rise. Part of the explanation could come down to timing. For example, a company might announce layoffs today, but it may take time before any employees are actually told who is being let go. Moreover, if the employees are to receive severance packages, it is often the case that the person will technically remain an employee during the severance period. Hence why layoffs announced today might take a few months before they show up in employment statistics.

Another possibility is that the people getting laid off are finding new work quickly. For example, it might be that the laid-off tech workers are finding jobs in the IT department of a non-tech firm. If that is the case, it would mean layoffs are merely causing more churn among workers but not a net decline in total employment.

Was there a resurgence in hiring in January?

What makes the jobs picture even more confusing is that the most recent payroll report showed a sudden surge in hiring, with the economy adding 517,000 non-farm jobs in January, up from just 260,000 in December. This could signal a reversal of what had been a trend of slower job gains in the second half of 2022.

Although, after looking deeper, we’re skeptical. First of all, January is a tricky month for estimating employment gains. Every January, millions of holiday workers get laid off (or their employment contract ends). Because of this, it is almost always the case that the raw employment change is negative in January. On an unadjusted basis, employment has decreased by at least 2 million jobs every January since at least 1990. This time that number was 2.5 million.

Economists want to know the underlying employment trend, not just capture the fact that there are always a ton of job losses in January. Therefore they use a tool called “seasonal adjustment” to take out this known January effect. In effect, these adjustments allow us to see whether the economy added or subtracted jobs net of the normal January layoffs. Note that while adjustments are made every month, January gets the biggest seasonal adjustment by far.

Typically these seasonal adjustments are very accurate and the best way to analyze the data. However, the larger the adjustment needs to be, the more room there is for error. In other words, it might be that the economy added 500,000 new jobs in excess of what we normally expect for January. But it might be that the adjustment overstated the “expectations” for job losses. 

No other indicators suggest a new hiring trend

Another reason for skepticism is that no other employment-related data point suggests there has been a surge in demand for workers. In other words, if there were a major change in job market conditions, we’d expect to see it in a variety of macro statistics, not just one. For example, ADP, a payroll service, does its own estimation of job gains. For January, the company estimated that only 106,000 jobs were added. The Institute of Supply Management does a monthly business sentiment survey, which includes questions on hiring intentions. The results for January show that both manufacturing and services industries don’t plan on expanding or shrinking headcount in the coming months. The National Federation of Independent Business does a similar survey of small business owners. This survey showed only a slight increase in “Hiring Plans” for January vs. December. 

None of these suggest that demand for workers has dramatically increased. If we combine all of this data with the fact that layoff announcements seem to be on the rise across a number of industries, it seems more likely that labor demand is steady and softening. 

It is generally the case that no one macro data point tells the whole story. So when we see an outlier like this January jobs report that is not corroborated by any other piece of data, we will not put much weight on the outlying data.

Is there such a thing as too many jobs?

Markets reacted negatively to the January jobs report, with the S&P 500 falling more than 1% that day. This continues a pattern of stocks falling in response to strong employment data over the last year, which in and of itself may seem confusing. Don’t we want there to be a vibrant labor market?

The problem is that it may be that the labor market is too strong. For several months Federal Reserve Chair Jerome Powell has described the labor market as “out of balance.” By this, he means that demand for workers is exceeding supply, which in turn is causing wage growth to exceed historic norms. From 2014-2019, Average Hourly Earnings rose at a 2.9% annual rate. Since 2021, it has grown at a 4.9% rate.

This wouldn’t be a problem except insofar as it fuels inflation. More income tends to lead to more spending. Fundamentally inflation is caused by the rate of spending outpacing the economy’s ability to supply goods and services. Hence if wages keep rising rapidly, it could result in ever-increasing spending. This could cause inflation to remain too high.

It doesn’t do workers any good to get a raise if all the extra money gets eaten up by inflation. So we do indeed want a vibrant labor market with workers in high enough demand to earn increased wages. However, we want enough “balance” so those higher wages don’t turn into inflation.

There are some encouraging signs. In recent months there has been only a minor slowdown in wage growth, and yet we have seen significantly slower inflation as consumer spending has slowed meaningfully. It appears that during the pandemic, Americans built up large savings balances and/or were not using their credit cards as much as they historically have. Starting in 2021 and into 2022, consumers began to reverse both these trends, spending down savings and ramping up credit card usage. In effect, this allowed households to spend well in excess of their income growth. The fact that consumer spending has recently stalled may signify that this normalization of credit card spending and savings levels has played out. If so, it could be that the labor market isn’t as much of an inflationary force as was generally assumed a few months ago.

Can inflation keep subsiding without job losses?

So the question then becomes whether this slower pace of consumption will continue even if the labor market remains strong. If this does occur, the Fed will probably stop hiking interest rates in the next couple of months. However, if wages reaccelerate, we suspect household spending will also rise. Perhaps not to the level of late 2021 or early 2022, but likely too strong for inflation to fall all the way to 2%. If that happens, we expect the Fed to keep hiking interest rates until the economy slows enough to bring more balance to the labor market.

In our view, looking at the totality of data on employment, we think the labor market is softening to some degree. While labor demand appears to be strong enough to absorb workers who are getting laid off, the mere fact that some companies are cutting while others are adding is a marked change from 2021 and early 2022. At that time, we heard pervasive complaints about a worker shortage, which stemmed from the fact that virtually every company wanted to add staff, and very few wanted to cut. They had no choice but to increase wages to attract the few employees who were available. 

Now with some companies hiring and others laying people off, this could be a version of the “balance” Powell has been discussing. If so, it could mean a slowing of labor demand without a major increase in unemployment, which could allow inflation to normalize while the economy continues to grow.

At Facet, we are still on guard for a recession in 2023 or 2024. So, as we said, the Fed may still need to keep hiking to actually damage employment. However, the fact that we already see a decline in inflation and a better balance in the labor market is a positive sign.