Labor Market Is Softening Further, Giving Comfort to the Fed
Labor Market Is Softening Further, Giving Comfort to the Fed
The latest jobs report released today shows that the labor market continues to soften. That should reduce inflationary pressures in the coming months and give the Federal Reserve greater confidence regarding the inflation outlook.
While the economy added 236k net new jobs in March, this number only tells part of the story. There are clear signs of a more broad-based slowdown in the report, with job gains becoming more narrowly concentrated in fewer industries, and wage growth continuing to soften.
The diffusion index, which gauges the breadth of employment changes across industries, decreased to 60.2 after averaging 71.5 in 2021 and 69.1 in 2022, as the economy added jobs across an unusually broad swathe of industries. Now, job growth is becoming more narrowly concentrated in fewer industries, and a growing number of industries are shedding jobs. The slowdown in interest rate-sensitive industries is spilling over into the rest of the economy. Historically, when the diffusion index has declined sharply, job growth has slowed in the following months.
The three industries that contributed the most to job gains in March were healthcare services, leisure and hospitality, and the public sector, accounting for 72% of all net new jobs added. This is in line with what we see in the online job postings data from ZipRecruiter’s marketplace, and other high-frequency real time data which show that consumer-facing industries are still experiencing strong business activity. Despite a recent decline in consumer spending on services, consumer sentiment has held steady in recent months, and restaurants, personal care, and travel-related businesses are still hiring.
Also, there has been a significant increase in job search activity as tech layoffs have been deteriorating the job seeker sentiment and many are trying to switch to jobs with better stability. This trend is in line with the high number of quits in Tuesday’s JOLTS report. Job seekers reprioritizing job security, in combination with softening in wage growth, have helped the public sector to ramp up hiring and recover the jobs lost during the early stages of the pandemic. Despite the acceleration in hiring, the public sector is still 314k employees short of its February 2020 employment level.
Industries that are more sensitive to interest rate hikes or that heavily depend on B2B services have experienced a significant slowdown. These industries, such as tech, financial services, construction, and temp help services also have a high share of small businesses. Credit tightening amid banking instability is likely to disproportionately affect small businesses with fewer than 50 employees more than large businesses, which might lead to further contraction in these industries in the upcoming months.
Wage growth was in line with expectations, down to 3.2% in March from 3.5% at a 3-month average annualized rate in February. This is in line with the Fed’s long-term target inflation rate. However, within the leisure and hospitality industry, wage growth accelerated in March, signaling that labor shortages are still lingering in the industry. But given the labor force participation rate for non-college degree holders—the biggest source of labor supply for the industry—went up from 56.0 in February to 56.3 in March, the wage growth is likely to soften in the coming months.
Overall, more employers are reporting that the hiring environment is becoming slightly less competitive, making it easier to fill open positions. The combination of slowing wage growth and rising labor supply should allow inflation to ease in the coming months. There is a risk, however, that the labor market could cool down too much. Instability in the banking sector, rising business uncertainty, and the delayed effects of jumbo rate hikes could cause labor market conditions to deteriorate more than expected.
