Job Openings, Recession Risks and Prospects for a Fed Reversal

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On Saturday, Sari and I made our annual pilgrimage to Kimballs for lobster roll.?Kimball Farm, which started as an ice-cream stand in Westford, Massachusetts, has ballooned into a huge enterprise over the years and there was a big crowd lined up in front of us when we arrived.?Undaunted, we traced our way to the back of the line and hoped it would move fast.?It did not.?

The problem of course was not just an excess demand for lobster roll – it was an inadequate supply of workers, as the students who had helped over the summer had returned to their studies.?Consequently, we had a nice hour-long wait, as the sun beat down on my tender Irish skin, to contemplate the consequences of America’s great labor shortage.?

Friday’s employment report showed plenty of momentum in the U.S. jobs market with 315,000 payroll jobs added across the economy in August.?However, last Tuesday’s JOLTs report was even more impressive with an increase in job openings from 11.0 million at the end of June to 11.2 million at the end of July.?Although this is down from a peak of 11.9 million at the end of March, it is still enormous relative to any time prior to the last year.?

Indeed, the job openings rate, which is defined as the number of job openings divided by the sum of employment and job openings, came in at 6.9% at the end of July, almost three standard deviations above its 3.4% average since the year 2000.?

Looking across the economy, every sector is seeing a shortage of workers.?However, the most acute problems appear to be in health care, where there are almost 2 million vacancies, and public education, where there are 360,000 unfilled jobs.?

It is remarkable that employers are still so hungry to hire after two quarters of negative real GDP growth and with consumer confidence near its lowest levels in 50 years.?That being said, we still expect job openings to gradually decline over the next few months for two reasons.?

First, with much slower demand growth many companies will discover that they no longer have the business to justify the positions they wanted to fill.?This should particularly be the case in construction, due to higher mortgage rates, manufacturing, due to a higher dollar, and retail, due to a squeeze on the budgets of lower- and middle-income households as federal government stimulus fades.?

In addition, on the supply side, we saw a welcome addition of 786,000 people to the labor force in the month of August and immigrant visas, having fallen precipitously over the worst of the pandemic, have averaged 14% above 2019 levels over the last six months.?While demographics remain a major drag on labor supply, the carrot of higher wages and the stick of fewer government benefits should also help lure workers back into the job market.

This excess demand for workers, particularly as it stokes hiring, is playing a major role in extending the current economic expansion.?For one thing, the National Bureau of Economic Research, which defines recessions in part by a lack of job growth, is very unlikely to declare the economy to be in recession while employment, as measured by both the household and payroll surveys, is rising.

Second, the tight labor market is generating substantial household income gains.?In the year ending in July, wage and salary income in the United States rose by $1.04 trillion, or 10.0%, reflecting a 5.2% increase in average hourly earnings and a 4.1% rise in payroll jobs.?This has partially offset the impact of declining government benefits over the same period.

However, emphasis should be placed on the word “partially”.?The reality is that, even with this increase in wage income, the personal savings rate fell from 10.5% in July 2021 to 5.0% in July 2022 which is well below its pre-pandemic average of over 7%.?In a similar vein, credit card debt rose by 14.4% in the year ended in June.?Even with rising wage income, American consumers are, to some extent living on borrowed time and borrowed money.

This is a critical issue for the conduct of monetary policy in the medium term.?

Even if wage gains remain strong, overall income gains will likely slow in the months ahead reflecting a lack of workers and slowly falling job openings.?

Demand in the economy will also be negatively affected by higher mortgage rates.?As of last week, the 30-year fixed rate mortgage rate was 5.66% compared to 3.11% at the end of 2021.?Soaring mortgage rates, hard on the heels of soaring home prices, mean that the monthly mortgage payment on the average new home with 20% down rose by over 60% in the year ending in July.?This will continue to weigh on home-building and home-buying, indirectly impact furniture and appliance sales and reduce the supply of home-equity loans.?It could also impede mobility as those wishing to sell in one city and buy in another get hurt by higher mortgage rates on both parts of the transaction.?The sad truth is that mortgage rates have been so low for so long that the U.S. housing market will have a very hard time adjusting to normal rates.

The higher dollar and weaker growth overseas should also hurt demand through lower U.S. exports and higher imports.?Over the past year, the trade-weighted value of the U.S. dollar has risen by 19%, pushing the real exchange rate to its highest level since 1985.?Meanwhile, the global manufacturing PMI index fell to its lowest level in over two years in August.?Trade data due out this week will likely show a sharp improvement in the U.S. trade deficit in July and this contributes to our view that the third quarter will see positive real GDP growth.?However, this will likely not continue going forward and international trade will likely be a drag on the U.S. economy throughout the rest of this year and 2023.

Finally, while recent polling has given Democrats some hope of holding onto the Senate in November, retaining control of the House remains very unlikely.?If Republicans do win a majority in the House, they are unlikely to support any further fiscal stimulus between now and the 2024 presidential election.?While this could contribute to a further decline in the federal budget deficit, it also represents fiscal drag which will tend to erode the spending of lower and middle-income consumers.

The bottom line for all of this is that, while we expect economic growth to be positive in the third quarter, it could slip negative in the fourth.?Moreover, in 2023, as the labor market returns to equilibrium, the economy will likely be plagued by inadequate demand.?While this will continue to put downward pressure on inflation, it will also leave the economy teetering on the edge of recession.?

In this environment, pressure will build on the Federal Reserve to provide stimulus by cutting interest rates and suspend balance sheet reduction just as was the case in the last long economic expansion.?However, just as was the case then, we expect that this would prove very ineffective, prompting the Fed to provide further monetary easing.?This could return the U.S. economy to an environment of low inflation, slow growth and, once again, low interest rates – not a particularly exciting one for American households but a supportive one for both U.S. fixed income and equities.

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