This Is An Outstanding Jobs Report

The new found relevance of the monthly jobs report is its impact on the rate of inflation, as a strong labor market tends to put upward pressure on wages, which then increases demand for goods and services, driving up prices. That runs counter to the Fed’s objective, which is why the central bank wants to see slower job growth and a declining rate of wage growth. This is what we have seen over the past 12 months, but that has raised new concerns that a weakening labor market will drive the economy towards recession. Today’s jobs report was the best of both worlds, as we saw strong job numbers with another decline in wage growth, which is the path to a soft landing for the economy.

The economy added an impressive 517,00 jobs in January and the prior two months saw upward revisions of 71,000. Leading the way in job growth was the leisure and hospitality sector with a gain of 128,000. The unemployment rate ticked down to 3.4%, while most of the other metrics were relatively unchanged.

We saw another decline in the rate of wage growth to 4.4% from what was 4.6% in December, which is exactly what the Fed wants to see. Meanwhile, the average workweek for all employees increased by 0.3 hours to 34.7, which largely offsets the easing in wage gains that could reduce weekly take-home pay.

It looks like this week’s spike in job openings for January was a tell for today’s number, but I think concerns about job openings are misplaced. We learned this week that the number rose to a five-month high of more than 11 million, which was up 600,000. The concern is that this will put upward pressure on wages, but the demand for labor is concentrated in lower paying positions in the accommodation and food services industries, as today’s jobs report showed. I noted last month that my daughter picked up a part-time job waiting tables over the holiday break, as she finishes her senior year at UNC. That job does not balance the income scale when a software engineer at Google is losing a position. This is the kind of job market that can help avert a downturn, while also tempering the kind of inflationary wage growth that the Fed is trying to avoid.

With all the consternation about a strong labor market and rising wages, it doesn’t really matter unless both are putting upward pressure on the rate of inflation. Yet that is not happening. Inflation continues to fall, despite the resiliency of the labor market. The Cleveland Fed provides a daily “nowcast” for the consumer price index (CPI) and personal consumption expenditures (PCE) price index, which have been relatively accurate. Note below where this model saw each metric for inflation in January at the beginning of the month.

Now look at the update below from yesterday’s report. The numbers for January are lower across the board. Better yet, the numbers for February show declines in every metric as well.

More relevant are the near-term inflation numbers, which give us an idea of where the annual rates are headed. Expectations for the first quarter of this year show rates in the Fed’s preferred gauge (PCE) with a 3-handle for the first time since this inflation cycle began. Provided we continue to see these rates fall, which is my expectation, it doesn’t matter if the job market remains strong and wage growth sustains at 4%.

It is also important to note that the monthly jobs report is a lagging indicator as it relates to forecasting economic activity. I don’t understand why it garners so much attention. If we want to get a better idea of when the recession everyone is expecting will begin, it is better to watch the year-over-year growth rate in real (inflation-adjusted) retail sales. Prior recessions did not begin until that figure declined within a range of 1-3%. We have come close in recent months, as one would expect in a significant economic slowdown, but the decline of 0.4% in December did not register.

I think real sales growth can sustain on the basis that real income growth returns as the year progresses. We saw a glimpse of that in yesterday’s US productivity report for the fourth quarter. While inflation-adjusted hourly compensation was down 3.4% for all of 2022, it rose 1% in the fourth quarter, which was the first positive reading of the year and marks an important turn in the rate of change. That should continue into this year as the rate of inflation falls faster than the rate of wage growth.

I expect we will see wage growth continue to ease in future jobs reports, but not to the extent that inflation does moving forward. That return to real wage growth should sustain real spending growth, albeit modest, and navigate the economy to a soft landing in 2023.

The market is likely to sell off at the open on the strong headline number for jobs, but the details of this report, along with the trend of disinflation that Chairman Powell mentioned this week, point to an eventual rebound in the major market averages. In fact, I’m sure Fed officials are cheering for a pullback that will modestly tighten financial conditions, but behind closed doors I’m sure they are exceedingly happy that we have the best of both worlds-disinflation along with full employment.