Chief Investment Strategist
Summary: US labor market strength was confirmed once again by a very strong nonfarm payroll report last week. Many investors have been puzzled by the sustained tightness in labor market despite reports of mass layoffs, primarily in tech sector, in Q4 2022 and again in Q1 2023. We explored the disconnect, and tech companies only appear to be removing some of their froth after massive hiring in the pandemic years. Overall, cyclical and structural trends point to shortages of labor supply, which means the slowdown in wage growth is still unlikely to be consistent with levels needed to bring inflation back to 2% levels.
The massive tech layoff wave that we have seen over the last few months hasn’t yet started to show an impact on the strength of the US labor market. Initial jobless claims, once again, were below 200k for the week ending January 28 and reached their lowest levels since April 2022. This is despite companies like Amazon, Microsoft, Meta and Salesforce slashing tens of thousands of employees ahead of the Q4 earnings reporting season.
To top that up, the non-farm payrolls report on Friday in the US was hotter-than-expected with gains of 517k in January and a net upward revision of 71k to the last two months of data. Other aspects of the report were also robust. Unemployment rate saw a surprise fall again to 3.4% from 3.5% (exp. 3.6%), the lowest since 1969. Average hourly wage growth was unchanged at the 0.3% M/M pace, while the Y/Y fell to 4.4%, still more than the expected 4.3%, and the prior was upwardly revised to 4.8% from 4.6%. This strong labor market report continues to question the concerns of a recession raised by reports of mass layoffs in the last few months primarily in the tech sector. We explore the disconnect below.
While tech layoffs have been making headlines, it is important to note that the major tech companies added new workers at a substantial rate during an ambitious hiring spree during the pandemic. So the current layoffs are a reversal of a small part of the pandemic-era hiring sprees, and do not constitute to any significant numbers. A large number of new projects were taken up in the easy money era by these tech players, and now as interest rates rise, these projects are likely to be re-evaluated. As projects are called off, layoffs are likely to widen further, but it is worth noting that tech companies are still employing more people than in the recent past. These job cuts signal potentially an effort to control costs rather than preparations for a deep downturn.
Outside the tech space, US labor market is still tight, with NFP data also reporting growth in jobs in sectors like government, healthcare, retail trade, professional and business services, construction, transportation and warehousing and manufacturing. Meanwhile, tech sector accounts for less than 5% of the total US employment, so the layoff reports are unlikely to move the overall needle on the US jobs front.
The labor force participation rate, at 62.4%, has drifted higher in January but remains well below pre-pandemic levels. The decline is being driven by older workers (aged 55+ years) leaving the labor market due to illness from long Covid, or early/normal retirement. This suggests a structural limit to the number of employable workers, or the labor supply and continues to complicate the Fed's job even more as policy makers try to crimp demand to push wage inflation lower.
The January NFP saw a significant upward revision for the last several months, somewhat resolving the puzzle of “missing” workers. But also consider that China’s population dropped by 850,000 people last year to 1.4118 billion, and this will mean a structural drag on global labor supply in the years to come.
As we have highlighted previously, markets are closely watching the developments in the US labor markets, with wage growth remaining a key driver of inflation and the path of Fed policy from here. From what it appears currently, the labor market remains far too tight and still a long way off levels that are consistent with bringing inflation back to 2% levels. Even as the labor market is loosening from peak tightness, it is rather gradual and much slower than the Fed forecast. Slowing wage growth may be an argument to support the Fed’s ‘disinflation’ rhetoric, but it is still hard to make a decisive turn.
Watching labor market data will be key from here, and that will include anything from the weekly jobless claims to JOLTS reports, Atlanta Fed wage tracker, to the employment cost index (ECI) and nonfarm payrolls. Next ECI is due on April 28, and that will be a key signal for the Fed to understand how wage dynamics are developing. But for now, there is enough reason for the Fed to continue to push for higher rates and drive out market’s expectations of this year’s rate cuts.
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