CONTRIBUTORS
Stephen Dover, CFA
Chief Market Strategist,
Head of Franklin Templeton Institute
Originally published in Stephen Dover’s LinkedIn Newsletter, Global Market Perspectives. Follow Stephen Dover on LinkedIn where he posts his thoughts and comments as well as his Global Market Perspectives newsletter.
At the US Federal Reserve’s (Fed’s) 2024 Jackson Hole Economic Policy Symposium, Fed Chair Jerome Powell stated that the US labor market is no longer overheated. Powell also noted that while inflation has abated, risks to growth and employment have increased.
For investors, Powell’s language is significant. Not only does it cement the case for the Fed to ease at its September 17-18 meeting, it also signals a readiness for further rate cuts through the end of the year and into 2025. Those moves could have profound implications for investment returns across asset classes.
The Fed has pivoted from fighting inflation to ensuring the health of the US economy. In what follows, we outline what data will matter most to the Fed and, by extension, for financial markets. Various key indicators will be revealed in the August employment report, slated for release at 8:30 am EST on Friday September 6.
While none of the labor market data can be ignored, a few indicators will take on added importance as the Fed and investors assess the health of the US economy. The top indicators, in our view, include initial jobless claims, non-farm payroll employment, the labor force participation rate, and temporary job losses.
Labor market normalizing
Importantly, the US labor market is normalizing, meaning that labor supply and demand are moving closer into balance. That follows a lengthy adjustment process following adverse labor supply shocks due to the COVID-19 pandemic. One example: The ratio of job openings to unemployed persons has decreased to 1.2 in June, close to its pre-pandemic levels.1
The biggest factor in restoring balance between labor supply and demand has been the return of workers to the labor force. The labor force participation rate for prime-age workers, aged 25 to 54, increased to 84% in July, touching its highest level in more than two decades.2 Increased labor supply relieves upward pressure on wages, which contributes to a moderation of business costs and hence in overall US inflation.
Concerns over recession risk are overstated
The rise in the unemployment rate to 4.3% in July triggered the so-called “Sahm Rule,”3 which has historically been a reliable indicator of US recessions. That may be one reason why the Fed has shifted its policy emphasis from inflation to growth. However, our analysis indicates that the Sahm Rule is a lagging indicator for the business cycle and is typically triggered once a recession is already underway.
More importantly, the Sahm Rule has historically been triggered by a larger increase in the number of unemployed persons as compared to the increase in labor force. That is not the case today. Instead, job gains remain positive, with the rise in the unemployment rate accounted for primarily by an increase in the participation rate as workers return to the labor force.
To be sure, a spike in temporary layoffs has also lifted the unemployment rate. That bears watching, should temporary job cuts become permanent. But we think it is premature to conclude that permanent job losses are likely, much less inevitable.
Watch payrolls
Historically, a triggering of the Sahm Rule has coincided with a US recession in every instance except 2003. Hence, the unemployment rate will remain a closely watched indicator. But investors are likely to look beyond the unemployment rate, per se. They will want to see whether any further rise in the unemployment rate is due to actual job losses or to further gains in labor force participation. That means weekly jobless claims (a rising number indicates more workers are being laid off), temporary layoffs becoming permanent, and the overall rate of nonfarm payroll gains (or losses) should be the key data for investors.
Based on data through July, changes in nonfarm payroll employment are not consistent with a deteriorating economic situation. Typically, when the economy is fully employed and economic growth is near its trend rate, monthly job gains are in the vicinity of 125,000.4 The three-month moving average of job gains as of July is 169,667,5 still above that pace. It is equally true, however, that the pace of jobs growth has declined since May. Markets will therefore watch the August employment report to see if the downward trend in jobs growth is extended. However, over the past month initial jobless claims have dipped, suggesting the pace of layoffs may be slowing. Recall, temporary distortions from Hurricane Beryl caused some of the increase in jobless claims.6
Conclusions
The Fed appears to have shifted its focus from inflation to growth, and with it to the US labor market. Although the rise in the unemployment rate has triggered the Sahm Rule, things look different this time. Job losses are modest and temporary, not large or permanent. There is not sufficient cause currently for alarm, in our view. Nevertheless, investors will likely be laser-focused on the US labor market, above all the key indicators of jobless claims, non-farm payrolls, temporary job losses and the participation rate for any signs of genuine growth and earnings risk.
Note:
Thank you to Institute analysts Karolina Kosinska and Priya Thakur for their research for this newsletter.
Endnotes:
- Sources: Bureau of Labor Statistics, Macrobond. Analysis by Franklin Templeton Institute.
- Sources: Bureau of Labor Statistics, Macrobond.
- The Sahm Rule identifies signals related to the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to its low during the previous 12 months.
- Source: Bureau of Labor Statistics. As of August 29, 2024. Analysis by Franklin Templeton Institute.
- Ibid.
- Texas accounted for 87% of the national rise in continuing jobless claims between the week of July 8 and July 15. Source: US Department of Labor. Analysis by Franklin Templeton Institute.
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