Labor Market Was Still “Too Hot” in September

If the goal is to bring down inflation as swiftly as possible, today's Employment Report for September showed the Federal Reserve they have a lot more work to do. Employment growth moderated to 263k jobs in September, down from 315k in August and an upwardly revised 537k in July, but that was still a touch stronger than the consensus forecast looking for 255k jobs and our forecast of 225k jobs. So far this year, monthly job growth has averaged a scorching hot 420k jobs a month, only a modest deceleration from last year's 562k a month pace.

U.S. Labor Market Has Rarely Been This Strong

To underline the point, the U.S. unemployment rate unexpectedly declined back to the July pandemic low of 3.5% from 3.7% in August. Not the direction the Fed is hoping to move the U.S. unemployment rate. In fact some FOMC members believe a non-accelerating inflation rate of unemployment or NAIRU may be somewhat higher than 4.0% today and may be as high as a 4.4% unemployment rate. In other words, just to stop inflation from accelerating the Fed may need to push the U.S. unemployment rate up nearly 1.0 percentage point above where it is today – equivalent to the destruction of around 1.4 million net jobs. Clearly, the U.S. labor market is not yet on that path and it will take more rate hikes from the Fed to ensure that path begins to materialize.

Low Unemployment Threatens To Keep Inflation High

Why the urgency to weaken the labor market? Wasn't the Fed recently trying to create jobs and strengthen the labor market during this pandemic? The reason, of course, is the severity and duration of the current inflation problem. The longer it takes for inflation to moderate, the more likely workers and employers will need to factor in that inflation into their wage negotiations and contracts and pricing decisions, ensuring a more prolonged inflationary problem, similar to the one the United States and the Federal Reserve faced in the closing years of the 1970's and early 1980's.

Average hourly earnings growth, while moderating a bit from recent peaks, is still running uncomfortably high (at 5.0% y-o-y) as employers continue to struggle with labor supply issues in many industries. Above average wage growth could keep a floor under consumer inflation, making it harder for the Fed to push inflation below 4.0% or 5.0%.

High Nominal Wage Growth Keeps Inflation In Play

The pool of available labor is virtually unchanged since June. In fact the labor force participation rate slipped a bit to 62.3% in September from 62.4% in August, and the employment population ratio was unchanged at 60.1%. The labor market participation rate has been treading water since it hit its post-pandemic peak in March. We obviously can't rely on a surge of folks entering the labor force to help relieve the current labor market imbalance. Better to face some mild economic and labor market pain today to avoid much more devastating outcomes down the road. Nobody wants to see another lost decade of stagnant growth and high inflation.

Looking at September job gains by industry this was another solid report. Goods producing industries such as manufacturing (+22k) and construction (+19k) continued to add net new jobs at a pace similar to previous months. Leisure and hospitality added a robust 83k jobs as food service and drinking establishments added 60k jobs. Health care added another 60k jobs as well and professional and business services had a strong showing adding another 46k jobs last month. There were a couple sectors that are starting to show modest net job losses. Retail trade and financial services lost 1k and 8k net jobs respectively, while government shed 25k jobs.

In short, economic and labor market resilience continues in the United States despite the mounting monetary and financial headwinds. It is far too early to see a Fed pivot away from further rate hikes given the current economic and inflationary environment. Fed funds futures are currently placing a 91% probability of another 75 basis point rate hike from the Fed in November and 100% plus probability of another 50 basis point hike in December in the wake of today's jobs report.

To learn more, check out this week's U.S. Outlook Report.