Key takeaways

• Payrolls surprised to the upside again in October with 261k jobs added. The majority of gains continue in lower paying services sectors, with some declines evident in interest rate sensitive areas of the economy, such as real estate.
• The unemployment rate increased to 3.7% as the number unemployed increased. Whilst the overall labor supply was a little lower and the participation rate remains well below pre-pandemic levels.
• Demand for labor remains robust with JOLTs job openings increasing to 10.7m in September, beating expectations for a decline, and reversing some of the decline seen in openings in August.
• This increase in vacancies left the ratio of jobs per unemployed worker higher back up to 1.86 near levels seen in June. This persistence in job openings will add to concerns that the path to a soft landing is narrowing as was acknowledged by the Federal Reserve this week.
• Various measures of wage, whilst moderating, still remain well above target consistent rates. Adjusting for the small uptick in productivity in Q3, productivity adjusted labor costs are also still outstripping the Fed’s 2% target.
• We continue to expect a further 100bps in tightening from the Fed, 50bps in December and February. Absent stronger shift on the demand side – terminal rates may well push higher than our current forecasts.

Today’s payrolls report confirmed that 261k jobs were added in October - stronger than the 193k expected by consensus and with an upward revision of 29k to the past two months of payrolls growth. It continues to be the case that we are seeing strong jobs growth in service producing industries with robust gains in leisure and hospitality and education and health services. Whereas for those interest rate sensitive sectors such as real estate, rental and leasing payrolls declined in the month with this likely to continue.

Source: BLS, Haver, abrdn, as of October 2022

The labor force participation rate declined a little to 62.2% versus a prior of 62.3% whilst the unemployment rate rose to 3.7% (see Figure 2). This reflects a fairly sizable flow of employed persons into unemployment, as the number of people employed declined by 328k, the number unemployed rose by 306k. Unemployment increased in manufacturing & construction and financial and other professional services industries in particular. Overall, the labor force declined by 22k people and whilst these data can be volatile from month to month the overall participation rate remains well below pre-pandemic levels.

Source: Source: BLS, Haver, abrdn, as of October 2022.

Alongside this, demand for labor remains robust with JOLTs job openings increasing to 10.7m in September, beating expectations for a decline, and reversing some of the decline seen in openings in August. The level of vacancies increased in health care & social assistance, accommodation and food services sectors, whilst job openings declined in finance and insurance, wholesale trade and manufacturing. Overall though, this increase in vacancies left the ratio of jobs per unemployed worker higher back up to 1.86 near levels seen in June but below the peak in July (see Figure 3).

Source: Source: BLS, Haver, abrdn, as of October 2022.

The Federal Reserve continue to expect that a softening in job vacancies is possible without the need for a large adjustment in unemployment but Chairman Powell did reference that the path to this soft landing has narrowed. We set out why we think a larger adjustment in the labor market is necessary in this note but given our view that the US will enter a recession next year, we expect the unemployment rate to increase through 2023.

Indeed, despite signs of a rolling over in various measures of wage growth these still remain well above target consistent rates (see Figure 4). When we look at the short run growth in wages, average hourly earnings growth surprised to the upside in October rising 0.4% versus the 0.3% expected, with negative base effects leaving annual growth slower at 4.7%. The Atlanta Fed’s composition adjusted wage growth tracker also slowed when smoothed to 6.7% y/y and the employment cost index for Q3 ticked down to 5.2%.

Source: Source: BLS, Haver, abrdn, as of October 2022.

Adjusting these labor costs for productivity growth, despite the return to positive productivity growth after a very weak H1, unit labor costs (ULC) still remain well in excess of the Fed’s 2% inflation target at over 6% (see Figure 5). These have moderated, reflecting both a slowing in labor cost growth and slightly higher productivity of labor . But it is still the case though that ULC growth is well elevated and a more significant improvement in the pace of productivity growth or marked slowing in compensation growth would be required to bring this back in line with the Federal Reserve’s 2% inflation target. We believe this adjustment needs to come through the compensation side and lower labor demand would be needed for wages to adjust.

Source: Source: BLS, Haver, abrdn, as of October 2022.

Given robust demand for labor, lack of improvement on the supply side and continued above trend wage growth we think the Federal Reserve still has more to do. We continue to expect the Federal Reserve to hike 50bps in December and 50bps in February. Should this strength in the labor market persist, there may well be upside risks to our terminal rate view given the adjustment we believe needs to occur for the Fed to meet its policy objectives.

Implications for investors

• The continued strength in payrolls growth, lack of improvement on the supply side and still strong wage growth all add to our view that a soft landing in the US economy is unlikely.
• Chairman Powell acknowledged at this week’s Fed meeting that the path to a soft landing had narrowed, and we still think the US will enter a recession next year.
• In light of today report we continue to see the Federal Reserve tightening policy further, 50bps in December and 50bps in February. But risks are to the upside on our terminal rate call, with perhaps more tightening necessary, to drive the decline in labor demand needed to bring wage growth back in line with target inflation.

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