When Will the Job Market “Break”?

In the wake of a bruising period of Federal Reserve Open Market Committee (Fed) tightening一undertaken to reduce inflation from its recent highs to its stated 2% target level一the US labor market remains resilient, with overall labor demand continuing to outstrip supply.

Weekly claims for unemployment benefits一while modestly higher than in previous weeks一remain relatively low at 229,000. 

Other labor metrics tell a similar story. Since last year the US Labor Force Participation Rate has trended upward to 62.6% but remains below its long-term average of 64.1%. Job openings have declined to 9.6 million一though nearly 1.6 positions remain open for every available worker.

These lagging indicators are in sharp contrast to leading economic indicators that clearly show signs of slowing growth, such as housing, manufacturing activity, and investment. These trends are reflected in the Conference Board US Leading Index (LEI), which currently show a year-on-year decline of -8.0%. 

Tightening credit conditions and the banking sector's recent weakness are also contributing to the current economic slowdown.

Still, despite moderating over the last year, April’s PCE Price Index (excluding food and energy) of 4.7%一a common measure of inflation一remains well above the Fed’s target rate of 2%.

The situation has important implications for the economy, ongoing Fed policy, and by extension, Hilton’s investment posture. In particular, understanding both the expansion and contraction phases of the market cycle一including which data is most critical一informs our process and positioning. 

While the economy appears to be in a declining growth phase, we have yet to see data indicating the labor market has “broken,” or loosened enough to rein in inflation to more sustainable levels. 

The question remains, when will these trends emerge?  Let’s take a closer look.

Why Is Labor a Lagging Indicator?

Compared to other economic data, labor statistics take longer to reflect economic activity and policy. 

Monetary policy actions, for example, move through the economy sequentially, with more interest-rate-sensitive sectors impacted first. This includes housing and investment. Declines in demand follow, weighing down manufacturing orders and corporate earnings. Eventually, the impacts seep into the labor market, typically resulting in reduced job openings, increased layoffs, and higher unemployment rates.  

Other reasons labor tends to lag include the following:

• Deferred Response to Shifts in Economic Conditions. During periods of economic expansion, businesses often delay hiring until they're confident growth is sustainable. Conversely, during economic downturns, employers may hesitate to lay off workers until they're convinced economic conditions won't improve in the near term.
  
  Interestingly, the current labor market may be experiencing aspects of both behaviors. Though coronavirus pandemic-induced layoffs were exceptionally swift, so too was the surge in unmet consumer demand that followed. Many companies are still reeling from these effects and may be reluctant to reduce headcount so soon after the challenging process of rehiring.

• Complex Data Reporting Processes. Gathering accurate and comprehensive labor market data involves collecting information from various sources, including surveys, administrative records, and employer reports. The process takes time, and once collected, data needs to be processed, verified, and aggregated before it can be reported.

Why the Fed Focuses on Jobs

The Fed’s dual mandate一to maximize employment and maintain price stability一reflects the integral connection between inflation and the labor markets. Examples include:

• The Wage-Price Spiral. A robust job market with a low unemployment rate indicates tight labor conditions, where employers compete for skilled workers. This can lead to increased wages to attract and retain talent. To maintain profit margins, businesses may pass on these higher costs to consumers by raising prices, which can contribute to inflationary pressures in the broader economy.
• Expectations & Inflation. Inflation expectations, or the anticipated future inflation rate, can also influence wage-setting behavior and pricing decisions. If workers and businesses expect higher future inflation, they may negotiate higher wage adjustments or set higher prices to account for expected inflation increases. These expectations can become self-fulfilling, leading to actual inflation.
• Consumer Demand & Pricing. A strong labor market boosts consumer confidence and purchasing power. Increased consumer demand can outpace the supply of goods and services, leading to upward pressure on prices.

To keep these elements in balance and, thus, help keep the economy on a sustainable growth path, the state of the labor market is a key Fed consideration.

When Will the Job Market Break?

In just over a year, the Fed has raised interest rates 10 times (5% total) in a forceful effort to normalize inflation. After its most recent rate increase early this month, the Fed Funds target range reached 5.00% to 5.25%ーlevels not seen since 2007.

And while most would argue the measures are working, a Fed pivot may still take time. In the words of Fed Chairman Powell earlier this month, “Reducing inflation is likely to require a period of below trend growth and some [additional] softening of labor market conditions.”

Hilton Co-Chief Investment Officer Alex Oxenham elaborates, “The Fed will need to see greater labor market loosening一evidenced by increased claims and unemployment rateーwe believe by as much as 1% to 2% (100 to 200 basis points).” 

When this occurs, and whether it will require additional policy firming, however, remains to be seen.

What Does This Mean for Hilton?

As with the Fed, our focus remains on the data. Our carefully considered macroeconomic outlook, further refined with relevant updates, provides the framework we use to navigate risk and portfolio composition.

For now, our posture remains cautious as the economy continues to absorb the impacts of Fed action and other relevant developments. Recent market rallies, primarily led by a narrow clutch of tech stocks, may prove unsustainable, adding risk to the equation. And though turbulence in the banking sector has fueled renewed hopes of a nearer-than-expected Fed pivot, this could prove elusive, at least until indicative economic data stop deteriorating.

As always, we’re committed to maximizing return opportunities throughout the market cycle一not only by boosting returns but limiting losses as the situation warrants. We will remain vigilant as conditions continue to unfold.