The Labor Market Is Coming for Profit Margins — or Worse
The economic downturn hasn’t been canceled for next year, but it may have been pushed back by another month or so. That’s the latest takeaway from US payrolls data, which showed resilient hiring and persistent wage increases in September. It marks yet another round of short-term good news for workers that’s bad news for companies and the Federal Reserve.
Ultimately, it’s hard to imagine how any of this ends well for anyone. Workers continue to quit jobs for higher-paying ones at elevated rates, which led to average hourly earnings in the private sector rising 5% in September from a year ago, still well above the rate that would be consistent with the Federal Reserve’s 2% inflation target. On a three-month basis, the picture is only marginally better at an annualized pace of around 4.4%.
The labor market just isn’t experiencing the sort of cooling that would allow the Fed to slow the pace of interest rate increases, which materially raises the risk of a recession. Indeed, even if wage pressures were ebbing in the data, there’s an argument that another bump could be in the offing in the coming months as companies head into performance review season and workers notice that inflation has eroded their purchasing power. Many workers took advantage of the hot job market to find a new role in the past year, but those who stayed will expect fatter-than-usual raises. If that happens, either company will raise prices further (damaging brand loyalty and incurring the wrath of the Fed); profit margins will shrink; or workers will be forced to suffer and, as a result, the consumer economy will sputter.
Shrinking Margins
Analysts see margins bouncing back soon, but are they too optimistic?
Source: Bloomberg Intelligence
Economic orthodoxy has long suggested that labor markets need to soften to tame inflation. While there are plenty of reasons not to treat that as an article of faith, the evidence from average hourly earnings takes the debate out of the realm of theory. The best-case scenario for the economy now is probably one in which workers decide to accept the loss in real wages — that’s just the cruel reality of how monetary policy is conducted, at least until central bankers find a better way. That might be the most likely path to a “softish landing,” as Fed Chair Jerome Powell has referred to it, in which the Fed is able to restore stable prices without causing a serious recession.
But it’s far from clear that the US economy is truly heading in that direction. Many employers are apparently still playing catch-up after the pandemic hiring challenges, and they added a seasonally adjusted 263,000 workers in September, well above the average of 190,000 a month in the five years before the pandemic. The unemployment rate fell to 3.5%, matching a five-decade low.
Optimists have long held that an improvement in labor supply could help bring wage increases to a more sustainable pace without necessarily driving up unemployment, but the prime-age employment to population ratio — the ratio of workers to people in the 25-54 age group — actually slipped a hair to 80.2% in the most recent month. Labor force supply looks like a nonstarter at this point, unless you believe that older workers will suddenly reconsider their retirements or that a change in immigration policy is in the offing.
Unfortunately, the stock market isn’t prepared for materially shrinking profit margins, much less a significant recession. Margins narrowed a bit in 2022, but they’re still relatively strong by historical standards. Until recently, companies have been able to pass along rising costs, but that won’t be the case indefinitely. Yet analysts and the market don’t seem to be discounting much more margin deterioration. In fact, projections compiled by Bloomberg suggest they’re expecting margins to bounce back in 2023 and 2024.
In the end, none of this bodes well for the broader economy, which is why the S&P 500 Index was sinking about 2% Friday. As Bloomberg Intelligence Chief U.S. Economist Anna Wong wrote, the labor market data “significantly bolster” the case for another 75-basis-point increase in the fed funds rate next month, potentially bringing the upper bound of the target range to 4%. The Fed’s decision will ultimately hinge on the consumer price index release expected Thursday. But with the job market this resilient, even a striking improvement in CPI would still leave the Fed to worry about what’s coming several months down the line. For companies and workers alike, it’s getting harder to see how any of this has a happy ending.
U.S. job growth slowed for the second month in September as employers added a still-solid 263,000 positions, signaling that high inflation, rising interest rates, and a softening economy are finally dinging the resilient labor market.
The unemployment rate fell from 3.7% fell to 3.5%, reclaiming a 50-year low, the Labor Department said Friday. But that's large because 57,000 Americans left the labor force, which includes people working or looking for jobs, even as payrolls expanded.
Economists surveyed by Bloomberg had estimated that 250,000 jobs were added last month. While the actual gain beat that forecast, it still amounted to the smallest advance since April of 2021.
The job market has been remarkably buoyant this year, notching average monthly gains of more than 400,000 despite the economy's challenges and the Federal Reserve's campaign to tamp down rising costs by making borrowing more expensive for consumers and businesses. Worker shortages have prodded many employers to continue hiring and avoid layoffs so they aren't caught flat-footed when activity rebounds.
"Job growth has slowed substantially over the course of 2022 as economic growth has softened but remains well above its pre-pandemic pace," says Gus Faucher, chief economist of PNC Financial Services Group.
What does the new jobs report mean?
The Fed is scrutinizing the monthly changes in employment to gauge whether inflation is cooling enough for officials to pull back the most aggressive rate hikes since the early 1980s. Those increases have slammed the stock market and raised fears of a recession.
In a sign that worker shortages could persist, the share of adults working or job-hunting edged down to 62.3% last month, leaving it well below the pre-pandemic level of 63.4%. The labor force participation rate generally had been rising and advanced sharply in August as workers returned to a sizzling labor market after caring for children or staying idle because of COVID-19 fears.
Is the jobs market still strong?
The dip in September suggests that finding workers could remain a challenge and push pay increases higher. That likely would further fuel inflation that’s just below a 40-year high.
Last month, average hourly wages rose 10 cents to $32.46, modestly lowering the annual increase from 5.2% in August to 5%, which is still a strong gain.
The renewed drop in participation, as well as the decline in unemployment and solid job gain, likely will help convince the Fed to approve another hefty three-quarters point interest rate hike in early November, economists say.
The report "is still a green light for more Fed rate hikes and higher interest rates," says Jason Schenker, head of Prestige Economics.
Why are stocks down?
Stock losses mounted following the release of the report. The Dow Jones Industrial Average slid 2% as of 12:53 p.m ET. The S&P 500 fell 2.6% and Nasdaq dropped by 3.5%. Yields on US Treasury notes jumped higher with the 2-year note touching nearly 4.3% and the 10-year at 3.9%.
What industry is hiring right now?
Leisure and hospitality, which includes restaurants and bars, the sector hit hardest by the pandemic, led the job gains with 83,000, though it remains 1.1 million short of its pre-COVID level. Health care added 60,000 and professional and business services, 46,000.
Manufacturing added 22,000 jobs as U.S. consumers continued to snap up goods even as a strong dollar hurt exports. And construction added 19,000, with companies still desperate to add workers because of longstanding labor shortages despite the downturn in the housing market.
But the public sector shed 25,000 jobs, largely because fewer school staffers returned to work last month than before the pandemic, reducing employment after seasonal adjustments.
Is a recession coming in 2023?
Many economists now believe the Fed rate hikes will tip the nation into a recession next year and the uncertainty is starting to take a toll on hiring. Payroll gains slowed from more than 500,000 in July to about 300,000 in August.
During that period, job openings – a gauge of future hiring -- fell sharply from a near-record 11.2 million to a still robust 10.1 million. With 1.7 vacancies for every unemployed person, workers still wield bargaining power. But that’s down from two openings per jobless worker the prior month.
Initial jobless claims, a measure of layoffs, last week rose to the highest level since late August but remain historically low. Announced job cuts surged 46% last month and employers unveiled plans to hire 380,000 workers, the lowest September total since 2011, according to Challenger Gray & Christmas, an outplacement firm.
Also curtailing employment last month: Employers brought on 1.3 million teens and young adults for the summer season and most returned to school, Goldman Sachs wrote in a research note.
Is there still a worker shortage in 2022?
At the same time, worker shortages are still plaguing most industries and many firms have resolved not to lay off employees even as the outlook darkens.
“Companies still don’t want to lose the talent – especially talent with tech skills – that they’ve worked so hard to win,” says Nicola Hancock, managing director of the Americas region for AMS, talent acquisition and advisory firm. “Even though the U.S. economy is contracting, we are still experiencing the most painful skills shortage we’ve seen in our history.”
The upshot: An unusual split in a cooling labor market, with some employers growing more cautious even as others continue to hire or at least avoid job cuts.
“Hospitality and airlines, for example, remain in catch-up mode having cut deeply through the pandemic,” Hancock says.
Tyler Sebastian, a cook and kitchen manager at a drug and alcohol rehab center in Garberville, California, was told this week the facility is closing.
The 32-year-old isn’t worried about finding a new position, though he is concerned he’ll have to take a pay cut after getting steady raises at the center during his four-year tenure. “There are jobs there,” he says. "I’m confident I will find something.”
What is the job market outlook?
Many economists expect the job market to lose steam more rapidly now that the nation has recovered all 22 million jobs lost in the health crisis and high inflation and interest rates are starting to dampen consumer and business spending. Monthly gains will likely fall to about 100,000 by the end of the year, according to Moody’s Analytics.
“Employment growth should decelerate more quickly as employers reduce hiring against a backdrop of a slowing economy and declining corporate profits,” economist Nancy Vanden Houten wrote in a note to clients.
This wasn’t the jobs report you were looking for.
The Labor Department on Friday reported that the economy added 263,000 jobs in September, down a tad from August’s gain of 315,000. That still counts as robust employment growth, though. Meanwhile, the unemployment rate fell to 3.5% from August’s 3.7%, matching the multidecade low it touched in July.
The drop in the unemployment rate is a problem. It came about in part because the labor force—people who are working or actively looking for work—shrunk. So, even though pandemic worries continue to abate, many people still aren’t going back on the job hunt. And that is helping keep the labor market very tight.
It is, of course, just one month’s worth of data. Moreover, the household survey that the unemployment and labor force figures are drawn from has a smaller sample size than the survey for the overall jobs figures, and that can cause some volatility. But the mood among Federal Reserve policymakers seems to be: “Show me that the labor market is cooling,” rather than “show me it isn’t.”
This is the last monthly jobs report that will come out before the Fed’s rate-setting committee meets next month, and it doesn’t seem like a strong argument to raise the target range on overnight rates by anything less than 0.75 of a percentage point.
One bit of positive news in the report, at least from an investor perspective, was that average hourly earnings rose by 0.3% from a month earlier, matching August’s gain but down from a 0.4% average pace over the first seven months of the year. So one can just about tell a story where the fall in job vacancies is leading to a reduction in competition for workers, and wage pressures are abating as a result. Not that it is a story the Fed seems likely to listen to at this point.
So what could change Fed policymakers’ minds on rates by their November meeting? The Labor Department’s September report on inflation, out next Thursday, could do the trick. It would need to show rather convincingly that consumer prices cooled last month. There is some evidence that might have happened—wholesale used car prices posted another drop last month, for example, while supply chain problems continue to ease and some retailers have inventory to unload.
Another thing that could change the Fed’s mind would be the emergence of severe stresses in financial markets—say signs of funding problems in overseas markets, a further surge in the dollar that threatens to destabilize major trading partners or a jump in long-term rates that adds to stresses in the housing market.
A friendly inflation report would be the preferable option.
The September jobs report beats non-farm payroll estimates, increasing by 263,000 jobs.
— Yahoo Finance (@YahooFinance) October 7, 2022
The unemployment rate falls to 3.5%. pic.twitter.com/oSpCpBR6Eh