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“Look beneath the surface; let not the several quality of a thing nor its worth escape thee.”

– Marcus Aurelius, “Meditations”

What has been driving job gains in nonfarm payrolls?

Better-than-expected U.S. economic growth has been driven by strong personal consumption and government spending. See our last post, U.S. Exceptionalism. Going forward, the labor market will have to play a key role in supporting consumption. Since the Federal Reserve started to hike interest rates in March 2022, the economy has added an average of 280,000 jobs per month, more than double the 50-year average. However, looking at the underlying details, we find that the strength of the labor market might not be as strong as it appears. As we highlighted in November post A Look Below the Surface of the Labor Market, much of the job gains since 2022 are in noncyclical sectors such as government and healthcare. In the latest jobs report, the gains in these two sectors accounted for 52% of the job growth despite representing only 25% of total employment.

In the healthcare sector, most job gains in 2023 could be attributed to a give-back from the large dislocation experienced during the height of the pandemic as healthcare workers exited the sector due to the stresses of being on the “frontlines.” (See below.)

Similarly, the government sector experienced weak job growth in the back half of 2020 through 2022 as government workers were drawn into the private sector by higher wages. To lure workers back to the government sector, state and local governments have increased wages. (See below.)

We have seen wage growth in the government sector outpace the private sector since the third quarter of 2023. While state and local government budgets are generally in good shape due to excess savings from COVID-19 relief programs and conservative management practices, rising labor costs could strain some municipalities. And, of course, higher labor costs might require higher revenues, aka higher taxes, which all else equal is a headwind to private consumption.

The strong job gains in the noncyclical sectors might be masking the weakness in the cyclical sectors. Other employment surveys, such as the NFIB Small Business Survey and ISM PMI employment print, indicate a softening labor market, as respondents continue to reduce headcount using layoffs, attrition and hiring freezes. The increasing share of the aggregate nonfarm payrolls from the healthcare and government sectors along with other deteriorating employment surveys might be better indicators of the state of the job market than the headline employment datasets themselves.