The December Employment Report was another strong one - once again highlighting the resilience of the current labor market expansion. Job growth did slow to 223k jobs in December from a downwardly revised 256k in November, but the net job gain once again managed to beat the consensus forecast of 203k jobs. For all of 2022 nonfarm employment was up over 4.5 million jobs despite the aggressive Fed rate hikes and hand wringing on Wall Street over an impending recession.
2022 Was Another Strong Year For Job Growth
However, the real surprise in the December jobs report was the drop in the U.S. unemployment rate back to its expansion low of 3.5% from a downwardly revised 3.6% in November and an October unemployment rate of 3.7%. This eye-opening and unwelcome drop in the unemployment rate over the last two months will arrive with a thud at the Federal Reserve that has been trying to engineer a labor market slowdown that will create more slack in the labor market (i.e. higher unemployment) and take some heat out of elevated wage and inflation pressures.
We and most economists were forecasting the unemployment rate would hold steady at a more comfortable 3.7% in December. Why the forecasting miss and what is behind the recent drop in the unemployment rate you ask? For one, the Bureau of Labor Statistics revised the household employment data used to calculate the U.S. unemployment rate all the way back to January 2018 as part of their annual seasonal adjustment factors revision. The drop in the unemployment rate in December came from a huge and unexpected 717k seasonally adjusted job gain in the household employment survey as the number of unemployed persons edged down to a modest 5.7 million from 6.0 million in November. At the same time the employment-population ratio improved by 0.2% to 60.1% and the labor force participation rate increased to 62.3% from 62.1% in November. These are all signs of a “hot” and probably still “over-heated” U.S. labor market environment.
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Unemployment Rate Lower Than March 2022
The only way to interpret all this new household survey data is to conclude the U.S. labor market was tighter than everybody thought over the last two months and actually got even tighter. In short, the Fed has a lot more work to do to bring meaningful slack to the labor market and cool wage growth to levels more consistent with a 2.0% inflation target. Based on today’s unemployment rate at a historically low 3.5% it is hard to say the Fed has made any meaningful progress on this front. Indeed, the unemployment rate today is lower than when the Fed starting hiking interest rates back in March 2022. The current median FOMC view is that a Non-Accelerating Inflation Rate of Unemployment or (NAIRU) in the U.S. is around 4.0% and Jerome Powell has said they may need the unemployment rate go above that level for a time to achieve the Fed’s 2.0% medium-term inflation target. Markets appear to be cheering the slowdown in the headline average hourly earnings growth to 0.3% in December from 0.4% in November, which helped bring the year-on-year average hourly earnings growth rate down to 4.6% from 4.8% in November. But given the continued low level of U.S. unemployment, it appears too early to declare victory on the Fed vanquishing wage inflation.
Earnings Growth Slows Again In December
Turning to the payroll employment details, notable job gains were seen in education and health care (+78k), leisure and hospitality (+67k), construction (+28k), and trade and transportation (+27k) in December. Though job growth slowed in five of nine major sectors compared to November.
Job Growth Cooling But Still Too Strong
Bottom-line, the U.S. labor market is cooling, but not quick enough to allow the Fed to pivot soon in their fight to move inflation back to 2.0%. The solid December Employment Report further increases the risk of a higher terminal Fed funds rate and higher interest rates in general in 2023 and elevates the risk the Fed will need to tighten into a recession to get their inflation task done.
To learn more, check out this week's U.S. Outlook Report.