Macro Signposts | 17 April 2024

Unless explicitly stated, views expressed do not constitute official PIMCO views.

Sorting Through Mixed Signals, We See Tight U.S. Labor Markets

Last week's edition of Macro Signposts explained our thinking on the outlook for Federal Reserve policy this year (read the full piece here). Back in January, the Fed suggested it may need two more quarters of "two-point-something" inflation in the U.S. before considering rate cuts. However, inflation has been much hotter since then. Thus, we argued there is a strong case to delay cuts past midyear, and possibly until December.

Retail sales data released on 15 April supports our view. Looking across a range of indicators, we expect headline real GDP growth between 2.5% and 3% in the first quarter. The second quarter could mark the fourth consecutive quarter of 3% or higher growth in final domestic demand, a "core" real GDP measure that excludes volatile trade and inventories components, a first since the 2000s. This continued resilience could keep stoking inflation as well.

What could spoil this and result in a sooner, faster Fed cutting cycle? Look to the other side of the Fed's dual mandate: employment.

Eyes on employment data
Swifter-than-expected easing in the labor market, with a rising unemployment rate and falling employment levels, could prompt the Fed to move quickly. But employment levels typically only drop during recessions.

Well aware of this, investors are focused intensely on the Labor Department surveys for any detectable weakness. These surveys are sending mixed signals: The gap has widened between employment levels reported in the household survey (of individual workers and families) versus the establishment survey (of businesses and other employers). Over the last six months ending in March, the household survey reported a net loss of 84,000 jobs, while the establishment survey reported a 1.5 million job increase. How can one survey appear recessionary, while the other depicts an economy with strong job growth?

Overall, we see reasons to be less concerned about a deteriorating labor market than a cursory read of the household survey would suggest. Knowing the strengths and weaknesses of each survey can help sort out the signals:

• First, for measuring employment levels, we tend to put more weight on signals from the establishment survey. By contrast, the household survey is designed to capture rates (e.g., unemployment and labor force participation rates). And while the household survey also reports employment, unemployment, and labor force levels, monthly changes tend to be volatile and prone to revision. The establishment survey, on the other hand, is designed specifically to capture monthly payroll gains and has a larger sample size. Although seasonal factors and the birth/death model adjustments may raise some skepticism about the establishment survey's ability to reflect real-time turning points in the economy, overall we believe this survey does a pretty good job of accurately measuring payrolls.
  
• Second, large inflows of immigrants over the last several years are likely distorting the household survey. The survey uses lagged population data, so it does not capture real-time fluctuations in immigration. Even after the data is revised, with a yearlong lag, it may still underestimate U.S. immigration by as much as 2 million, according to Congressional Budget Office estimates. This can skew levels of the labor force, employment, and unemployment reported in the household survey.
  
• Third, post-pandemic shifts in labor markets and employer preferences could be contributing to differences between the surveys. An interesting feature of the post-pandemic labor market has been the decline in average weekly hours despite the still somewhat elevated level of posted job openings. In other words, employers in general appear to prefer having more individuals working fewer hours. Presumably, this evolution resulted from higher levels of turnover, sickness, and general absenteeism amid the pandemic. The flip side of this trend has been a notable rise in individuals working multiple jobs. The establishment survey would capture the multiple jobs – a better measure of labor output – while the household survey would reflect just one employed individual.

The net result is a considerable divergence in employment reported by each survey. In our view, the household survey is projecting weaker signals about the U.S. economy than warranted by underlying fundamentals.

Furthermore, when comparing GDP with labor market trends of each survey – a so-called Okun's law relationship – the establishment survey appears to be tracking reported GDP more closely.

The labor market seems tight
Taking all of this into account, we believe the U.S. labor market has resolved a good portion of the supply/demand imbalances that spiked during the pandemic, when extreme labor scarcity drove up wages. Still, with household survey unemployment rates low, establishment survey payroll gains healthy, and immigration boosting both labor supply and demand, we still believe labor markets are tight overall – and we are comfortable discounting some of the more recessionary signals as noisy indicators from imperfect surveys.

Read the previous edition of Macro Signposts on the outlook for Federal Reserve policy in light of inflation and other macro trends.

We welcome your questions about the global macro landscape. Don't hesitate to suggest themes or data for us to analyze and discuss: Please email [email protected].

For regular insights on U.S. policy via email, please write to [email protected] and ask to receive the Washington Watch.

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