The Lowest U.S. Unemployment Rate Since the 1960s: What We Need to Look At

In the first U.S. employment report of this year, 223,000 jobs were added and the unemployment rate came in at 3.5%.

This is the lowest level since the 1960s, and given last year’s negative GDP in the first half, it shows that the labor market is extremely strong.

All sorts of economists warned that a recession would hit in 2023, but the labor market seems to be laughing at them.

However, it is risky to interpret this data alone as meaning we are completely free from recessionary pressure.

Working harder and working longer hours does not magically create money that doesn’t exist.

Money is not manufactured; it is earned.

What this means is that, in the end, Powell has to cut rates for money to flow into the market.

There has to be money in the market for companies competing in that market to share it. Investing in the companies that are competitive in this process is what we think of as “investing.”

A solid unemployment rate does not automatically mean that companies will make more money.

The reason investors like to hear that the labor market is strong

is not because “companies will be able to earn more” but because they think “maybe a recession won’t come.”

Coming back to the topic of interest rates,

Everyone knows that the reason rates are being raised is inflation.

And inflation happens when people have more money than they need, which leads to unnecessary spending and investing.

If you stop giving out money (raise interest rates), people can’t spend as much, and inflation eases.

Conversely, once inflation eases because people are unable to spend freely, there is no need to keep withholding money (raising rates).

To sum up so far,

A solid labor market has only gone so far as to ease recession fears,

and in the end, inflation has to come down because people can’t spend as much before rates can be adjusted,

and only when rates come down will more money flow into the market and allow it to really take off.

There is a reason I am going over basic points that may feel almost boringly obvious to some people.

If you think about what actually reduces people’s spending power, you can see that wage growth is the key.

Fortunately, wage growth is on a downward trend.

In this jobs report, private-sector wages rose 4.6%, and pay for production and nonsupervisory workers rose 5.0%, both better than economists had expected.

Looking only at the data so far, wage growth is slowing, unemployment is near record lows, and the pace of rate hikes is moderating:

it is hard not to hope for Powell to pull off a beautiful soft landing.

However, this wage growth rate is based on employees who stay at their jobs, and the real problem arises when everyone starts dreaming of a brighter future.

The more people are hired, the more companies begin to feel the strain.

When many people are being hired, wage growth has to slow more sharply for companies’ burdens to ease.

Unless corporate earnings improve significantly, it is nearly impossible to keep hiring while maintaining current wage levels.

On top of that, delivering strong earnings when liquidity has dried up in the market is at least twice as hard as doing so when money is plentiful.

According to ADP, since May 2021 the wage gap between job changers and job stayers has been widening.

The fact that this wage gap between job changers and job stayers continues to persist means that

companies are under pressure to hire, while workers are switching jobs to secure higher pay.

From the perspective of companies that find it difficult to cut existing employees’ wages,

ultimately, the only way to save on expenses and withstand the current environment of rising interest rates is not to take on these job changers.

Of course, if an industry has virtually no job changers, this is not an issue.

However, the leisure and hospitality sector (purple), which has surged since April 2021, still recorded the highest number of hires among all industries as of December 2022.

In other words, it is the sector currently driving the labor market.

Yet this sector is also the one with the shortest average tenure, where job changes are most frequent.

This means that the leisure and hospitality sector, which has contributed significantly to the rapid increase in employment, could see wage growth cool more slowly than in other industries.

If things play out this way, companies will start to feel the strain and move to lay people off, and because this sector has been such a big driver of job gains, the overall unemployment rate could spike sharply.

The key point here is that companies begin to feel the pressure.

For companies to feel that pressure,

Powell has to look at the solid labor market, feel reassured, and keep rates high.

And investors, seeing the same strong labor market, will also feel reassured.

It is a situation where no one can really relax until Powell either declares that he is done hiking or actually starts cutting rates.

In the end, it all comes down to timing. If wages are coming down while a large number of job switchers are laid off and fail to return to work,

consumer spending, which makes up a large share of GDP, could fall, and Powell’s soft-landing scenario could fall apart.

We’re rooting for you, Chair Powell.

Three-line summary:

1. Leisure and hospitality has led the labor market: it is the sector with the shortest average job tenure.

2. Overall wage growth is slowing, but wage gains for job switchers remain significantly higher than for job stayers.

3. If Powell uses strong labor data to justify keeping rates high, the overall unemployment rate could rise sharply.