Is the Fed Ignoring the Red Flags in the Labor Market?

The Labor Market Shift: A Case for Fed Pivoting

In 2022, I presented the argument that the Federal Reserve would not pivot until the labor market showed significant signs of weakening, a stance I refer to as the “cover cuts” policy. It requires the Fed to induce a slowdown in employment such that any subsequent rate cuts will be widely accepted. Recent jobs reports, including negative revisions, have solidified the need for imminent Fed intervention.

1. Persistent Restriction Despite Rate Cuts

• The Fed has already slashed interest rates three times in 2022, yet they remain in a restrictive policy phase.
• The discussion on transitioning to a neutral stance on rate cuts is just beginning, with no indication of a natural pivot.
• Any accommodative policy hints are notably absent, implying that the Fed does not perceive an imminent economic breakdown.

1. August Jobs Report Insights

• Total nonfarm payroll employment grew by 142,000, with little change in the unemployment rate at 4.2%.
• Job gains primarily occurred in construction and healthcare sectors.
• The current unemployment rate of 4.2% reflects increased job seekers who are unable to secure employment.
• Notably, the unemployment rate for those without a high school diploma stands at 7.1%.

1. Job Creation Dynamics

• While manufacturing experienced setbacks, construction employment showed growth.
• However, the latest data indicates that residential construction workers remain at risk, emphasizing a key trend to watch.
• Despite a job loss in recent months, the construction sector saw employment gains in the latest report.

1. Slowdown in Labor Market Momentum

• The recent labor market averages reflect a cooling trend: 116,000 monthly job creations in the last three months and 164,000 in the last six months.
• This diminishing pace aligns more closely with the expected job curve for economic stability without a recession.

Jobless Claims and Job Openings

• The four-week moving average of jobless claims remains a crucial indicator for a potential job-loss recession, even though claims are currently subdued.
• Job openings have declined from record highs to 7.6 million, signaling a significant shift despite remaining above pre-COVID levels.
• However, data on quit ratios and hiring shows fragility, indicating a potential need for rate cuts to support economic growth.

In conclusion, the current state of the labor market necessitates swift action from the Federal Reserve to uphold its dual mandate. Striking the delicate balance between stimulating economic expansion and avoiding a downturn is vital in the coming months. As rate cuts loom, the impact of lower mortgage rates and a dovish Fed on sustaining the expansion remains a key question for the future.