By Dr. Uric Dufrene, Sanders Chair in Business Professor of Finance, Indiana University Southeast
Last Friday’s employment release was described by some as a “Goldilocks” report, and there were indeed several aspects to be excited about. The equity markets showed approval and the Dow surged by almost 700 points.
First, the nation added another 223,000 in December. While this is still above what would be considered “normal” expansion, payrolls showed another deceleration from the previous month. Payroll growth is certainly declining, with the past six months showing deceleration, and the December gain was the lowest in two years. More jobs were gained in the service sector, outpacing goods job growth by 180,000 to 40,000.
In addition to payrolls expansion, there were two other significant highlights. First, the labor force expanded by 439,000, the largest increase since August. Gains in the labor force also occurred with solid employment gains, increasing by 714,000. An expanding labor force, along with a surge in employment, combined to reduce the unemployment rate to 3.5%.
The second piece of the report with market significance was the increase in average hourly earnings. Hourly earnings only increased by 9 cents, and this was below market estimates. The cooling in average hourly earnings is what the market was really responding to with the surge in the Dow, S&P, and the NASDAQ. Cooling wages is music to the Fed’s ears, and the employment report provided further evidence to market participants that 2023 will result in a less hawkish Fed.
Softening wage growth coincides with data showing that prices also continue to cool. The last Consumer Price Index (CPI) showed annual inflation declining to a little more than 7%. This is down from a peak of 9% back in June. The core rate (CPI less food and fuel) is just under 6%. To be sure, there is still room for price declines with the Fed’s preferred inflation rate at 2% annual rate. The battle shaping up this year is between the Fed and financial markets. Fed speakers continue to display hawkishness, advocating for additional rate increases. The financial markets continue to price in declining rates, however. The 10-year Treasury Yield has declined to 3.5%, down from 2022’s peak of 4.2%. Market pricing of inflation, five years out, has declined from 2022’s peak of 3.5% down to a little more than 2%.
As we pointed out in a column back in August, data continue to point to past peak inflation. We will continue to see price declines, and the CPI will decelerate further once housing price changes begin to take effect. Home prices are a significant component of the overall CPI, but there is a lag between actual home prices and the impact on CPI. As softening home prices take effect on the CPI, we will likely see effects on CPI reductions. This will then lead to rising dove voices among the Fed.
We have one month to go for metropolitan data, but it appears that Louisville Metro will have one of the best years of payroll expansion in over 30 years. Louisville is on track to gain about 30,000 jobs over the year. Not counting the abnormal changes in 2021, this would be the highest gain on record in 30 years, and perhaps in the history of the series. Our 2022 outlook called for solid payroll gains in Louisville Metro and the record certainly points to that.
In addition to prices beginning to moderate, other signs of the economy slowing down are emerging. The ISM manufacturing index is under 50 which means that the manufacturing sector is contracting. The big news, however, came on the services side. The ISM services index also fell under 50. This was the first time under 50 since April 2020, the depths of the pandemic effects on the economy.
Despite the slowdown, the labor market continues to show resilience. Unemployment claims declined last week and are significantly under a level consistent with any recession. Monthly payroll gains continue to run strong, and equity markets are not pricing any deep recession. In sum, the data are shaping up in such a way that a soft landing, while not necessarily ruling out a recession, maybe the eventual outcome.