Employment and the risks of recession

ECONOMY & POLICY

June 03, 2022

Chief Economist Eugenio J. Alemán discusses current economic conditions.

We remain in the camp that the Federal Reserve (Fed) will be able to engineer a soft landing and will spare the economy from a recession. However, the strength of May’s employment report did not help our position.

Total job creation was a strong 390,000 during the month. Lower than the previous month’s 436,000 but still healthy. If this rate of job creation is maintained, the US economy will achieve its pre-pandemic job levels by the end of August or September. However, it is also true that employment creation is slowing down and May’s increase was the weakest job number since the 263,000 reported in April of last year.

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Today’s negative market reaction to the jobs number seems understandable. Normally, markets like strong job numbers. However, they see May’s jobs report as still too strong to keep the Fed from having to increase interest rates so much that it would trigger a recession.

The Fed is in a bind today. Its two main mandates are “maximum employment and price stability.” And it is not achieving either of those mandates today. The number of jobs is still 822,000 lower than the prepandemic level while inflation is running at levels not seen in 40 years.

But the May numbers hide some positive signs for those that think the Fed can engineer a soft landing. Job creation in the goods producing sectors continued to slow down, with the motor vehicles and parts sector shredding 3,500 jobs during the month after adding 18,400 in March and 7,500 jobs in April. Meanwhile, the non-durables goods sector added 7,000 jobs in May after adding 17,000 and 27,000 in March and April, respectively.

Construction jobs have been up and down lately, increasing 22,000 in March while not adding any new jobs in April. The construction sector added a strong 36,000 new jobs in May and that seems to add to evidence that the sector is not slowing down as some analysts have indicated. However, such a strong number is not uncommon if the industry sees a slowdown coming its way and increases jobs in order to finish ongoing construction projects before price appreciation reverses and/or home sales continue to slowdown.

It is very difficult to believe that the strong increase in mortgage rates over the last three months is not having any effect on the housing market. Thus, we still believe that the slowdown in the housing market is ongoing and will be reflected in the numbers released going forward.

We will probably see further improvement in leisure and hospitality as well as other services and mining and logging jobs going forward as those are some of the sectors that remain way below their pre-pandemic levels. However, these are jobs that were eliminated during the pandemic so they should not be of concern for the Fed as it gauges what to do next.

Meanwhile, the participation rate continued to improve, meaning that the current employment environment is still able to bring people back into the labor force. This has enabled the rate of unemployment to remain at 3.6% in May, unchanged from its April reading.

Average hourly earnings were up 0.3% in May, down from an increase of 0.5% in April. On a year-earlier basis, average hourly earnings were up 5.5%, down from a year-earlier rate of 5.6% in April. However, real average hourly earnings were down 0.1% in May compared to a decline of 0.7% in April. On a year-over-year basis, real average hourly earnings were down 2.6% in May, a similar rate to the one reported in April.

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Clearly, this report supports the argument that consumers continue to shift from buying goods to buying services. This is consistent with our view that price pressures in the goods sectors is going to ease and help to slow inflationary pressures coming from the goods sector.

Granted, the Ukraine-Russian war remains the most important risk to any inflation forecast due to the effect it is having on petroleum and gasoline prices. However, continued pricing pressures from the goods sectors should continue to abate and help overall inflation in the US.

Inventory and Sales:

Several weeks ago, comments by large retailer chains in the US spooked the markets and threw them into a downward spiral. The comments were geared toward changing consumer behavior, which was putting pressure on inventories as consumers refrained from buying durable goods and shifted their behavior into the consumption of necessities. Thus, this week we are going to look at whether there are indications of this behavior from the data that has become available since the comments were made in mid-May.

In order to do this, we looked at two measures of inventory to sales ratios: retail inventory to sales ratios and wholesale trade inventory to sales ratios. The caveat is that the data goes only until March. Thus, this will be one of the variables we will be keeping track as the year progresses. Furthermore, even if the inventories to sales ratios start to increase, this will help put downward pressure on prices rather than leading to a recession.

From looking at the ratio of inventories to sales both at the retail as well as at the wholesale level there may be some indication of upward movement in inventory to sales ratio for some sectors, but there is little evidence that inventory accumulation is a serious issue for either retailers or wholesalers.

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What is clear from the information on inventories to sales ratios is that every sector is different and many of these ratios have been coming down rather than going up. Perhaps the exceptions are the sectors related to the housing market, whose inventory to sales ratios have been pointing up lately. Below is a graph that includes sectors related to the housing market and almost all of them have increased in the last several months except for “lumber & other construction materials.”

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On the retail side of the inventories to sales ratios we see something similar with the “furniture, home furniture, electronics, and appliances stores” sectors as well as with the “building materials, garden equipment, and supplies dealers,” as the inventory to sale ratio for those sectors of retail have also seen some upward momentum.

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However, these sectors’ inventory to sales ratios are still close to pre-pandemic levels and don’t seem to be overextended, of course, at current sales levels. Sales could start to slowdown in the coming months and these ratios could start to look concerning. If this happens, firms are going to start cutting back on purchases and/or production and this will start to feel like the slowdown that almost everybody is talking about. As of today, however, there are no signs that an accumulation of inventories is an issue that could prompt immediate concerns about the US economy.

Summary of the week:

FHFA Home Price Index: The FHFA house price index for single-family homes increased 18.7% during the first quarter of 2022 compared to the same quarter a year earlier, according to the Federal Housing Finance Agency. Compared to the fourth quarter of 2021, home prices were up 4.6%. Meanwhile, the seasonally adjusted monthly index was up 1.5% in March compared to February. According to the agency, “strong demand coupled with tight supply have kept prices climbing. Through the end of March, higher mortgage rates have not yet translated into slower price gains, but new home sales have dropped during the last few months, with a significant falloff in April.” The S&P CoreLogic/Case-Shiller 20-City Composite Price Index increased 2.4% in March compared to February on a seasonally adjusted basis. Consensus was expecting an increase of 2%. On a year-earlier basis, home prices increased 21.2% compared to consensus expectations of a 20.2% increase. Home price appreciation remained “alive and well” in March, according to both the FHFA home price index and the S&P CoreLogic Case-Shiller price index. If there were signs of a slowdown in home sales, this slowdown has not yet affected home price appreciation across the country.

Consumer Confidence Index: The Consumer Confidence Index published by the Conference Board continued to indicate the impact of higher prices on consumers’ view of the current economic environment. Consumers also indicated that they are starting to see some softening in the labor market. The Consumer Confidence Index declined slightly in May, according to the Conference Board. The Index dropped from 108.6 in April to 106.4 in May. The Present Situation Index, which is based “on consumers’ assessment of current business and labor market conditions” declined from 152.9 in April to 149.6 in May. Meanwhile, the Expectations Index, which is based “on consumers’ short-term outlook for income, business, and labor market conditions” declined to 77.5 from 79.0 in April. According to the Conference Board, the Present Situation Index declined mostly due to a perceived softening in the labor market. However, the view on current business conditions improved in May. Purchasing intentions for big ticket items such as cars, homes, major appliances, etc., cooled in May, a reflection of the increase in interest rates and a shift in consumption from big ticket items to services, according to the Conference Board. Inflation remained top of mind for consumers. However, inflation expectations remained virtually unchanged in May but at elevated levels. However, consumers’ view of business conditions improved in May compared to April even though overall consumer confidence fell slightly. The May results also show the shift in consumer behavior from buying durable goods to spending more on services, which is something that needs to happen in order to reduce the pressure on goods prices.

Employment Report: This was a strong employment report with the service sector remaining the driving force for job creation. At this rate, the US economy should achieve pre-pandemic job levels by late August or early September. Total nonfarm payrolls increased 390,000 in May, according to the Bureau of Labor Statistics (BLS) while the rate of unemployment stayed at 3.6%, unchanged from April. Total private jobs were 333,000 higher in May. There were 59,000 jobs added in the goods producing sectors while most of the jobs added were in the service sector with 274,000. Government jobs added 57,000 to the top number. By sector, mining and lodging added 5,000 jobs, construction added 36,000 while manufacturing added another 11,000. Retail trade was, perhaps, the outlier in May, shedding 60,700 jobs during the month. Wholesale trade added 14,100 jobs while transportation and warehousing added 47,000. Another notable sector contributing to May’s increase was the professional and business services sector, with the addition of 75,000 new jobs. Meanwhile, education and health services added 74,000 jobs, of which 42,100 were in the health care and social assistance sector. The leisure and hospitality sector, on the other hand, was the strongest job creator in May, increasing by 84,000. Overall, this was a strong employment report with the service sector continuing to recover from pandemic-induced job losses. We should expect this trend to continue as the economy continues on its path to fully reopen during this summer season with leisure and hospitality jobs leading the way.

Construction Spending: The private side of the construction sector remains strong while public sector construction remains weak. Total construction spending increased 0.2% in April compared to March on a seasonally adjusted basis and by 12.3% on a year-earlier basis, according to the Census Bureau. Residential construction increased 0.9% versus March, on a seasonally adjusted basis while increasing 18.2% versus April of last year. Non-residential construction, on the other hand, declined 0.4% versus March on a seasonally adjusted basis while increasing 6.6% versus April of last year. Within total construction, total private construction increased 0.5% versus March of this year while increasing 15.3% versus April of last year. Although construction spending increased less than consensus expectations, 0.2% versus expectations of 0.5% growth in April, the sector continued to expand on a year-earlier basis. Private construction remains strong but total construction is being dragged down by the weakness in public construction.

Job Openings & Labor Turnover (JOLTS): Although this JOLTS report was weaker than last month, it was still very strong and points to a still strong labor market in the US. Job openings decreased to 11.4 million at the end of April, according to the US Bureau of Labor Statistics. This was down from almost 11.9 million in March but higher than the 9.3 million in April of last year. Hires also dropped a bit in April, from 6.65 million in March to 6.59 million in April. Total separations were down in April, to 6.03 million compared to 6.25 million in March. Although job openings and hires declined a bit compared to March of this year, they remain very strong. Meanwhile, total separations declined, which also points to the staying power of employment in the current environment.

ISM Manufacturing: The US manufacturing industry remains in expansion mode and seems to have strengthened a bit lately. Overall, the report was very positive for the overall health of the US economy. The manufacturing ISM was better than markets were expecting in May, according to the Institute for Supply Management. The Index was 56.1% compared to a 55.4% reading in April versus consensus expectations for a 54.5% print. May ISM manufacturing increase was the 24th consecutive expansion reading for the Index since it experienced the pandemic contraction in April and May of 2020. There were improvements in the New Orders Index, the Production Index, and the Backlog of Orders Index. However, the Employment Index dropped into contraction territory, at 49.6% compared to a reading of 50.9% in April. Meanwhile, the Supplier Deliveries Index was down to 65.7% compared to a reading of 67.2% in April. The Inventories Index was 55.9 %, up from a reading of 51.6% in April. The New Export Orders Index was 52.9%, or 0.2 percentage points higher than April’s reading. Meanwhile, the Imports Index dropped to contraction territory, at 48.7% compared to a reading of 51.4% in April. The Price Index was 82.2% in May, down from a reading of 84.6% in April. The May ISM Manufacturing Index seems to confirm several trends observed in other economic indicators. That is, prices seem to have peaked while employment seems to have started to slow down, exports continue to increase while import growth has cooled down considerably.

ISM Services: The US service sector continues to expand but at a slower pace, according to the Services PMI with two of the four components of the Index reporting lower numbers in May compared to April. The Employment Index moved into expansion territory, adding to the strength of employment in the service sector that we saw earlier with the release of the nonfarm payroll report. The service sector continued to expand in May, according to the Institute for Supply Management. The Services PMI was 55.9% in May compared to 57.1% reported in April. The May report showed further slowing of the service sector. The Business Activity Index was 54.5% compared to a reading of 59.1% in April while the New Orders Index was 57.6% compared to 54.6% in April and the Employment Index was at 50.2%, up from a 49.5% reading in April. Meanwhile, the Supplier Deliveries Index was 61.3% compared to 65.1% in April. The Services PMI continues to show expansion in the service sector, but it is also showing that the expansion is slowing down. Out of the four large components of the Index, two, the New Orders Index and the Employment Index, saw an improvement from their April readings.

Economic Forecasts:

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Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those Raymond James and are subject to change without notice the information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Studies. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

The producer price index is a price index that measures the average changes in prices received by domestic producers for their output. Its importance is being undermined by the steady decline in manufactured goods as a share of spending.

Industrial production: Industrial and production engineering is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

FHFA house price index is a quarterly index that measures average changes in housing prices based on sales or refinancing's of single-family homes whose mortgages have been purchased or securitized by Fannie Mae or Freddie Mac.

Consumer confidence index is an economic indicator published by various organizations in several countries. In simple terms, increased consumer confidence indicates economic growth in which consumers are spending money, indicating higher consumption.

ISM Manufacturing indexes are economic indicators derived from monthly surveys of private sector companies.

ISM Services Index is an economic index based on surveys of more than 400 non-manufacturing (or services) firms' purchasing and supply executives.

Non-Manufacturing Business Activity Index is a seasonally adjusted index released by the Institute for Supply Management measuring business activity and conditions in the United States service economy as part of the Non-Manufacturing ISM Report on Business.

New orders index measures the value of the orders received in the course of the month by French companies with over 20 employees in the manufacturing industries working on orders.

Source: FactSet, data as of 6/3/2022