The labor market has returned to its pre-pandemic balance, showing strength and resilience as reflected in the May employment report, which confirmed that job creation in the US economy remains robust. But despite this positive outlook, labor market indicators now send a more inconsistent signal compared to the pre-pandemic period, Goldman Sachs economists said Monday.
In their analysis, economists highlight three notable weaknesses in the labor market data and examine the potential implications for the Federal Open Market Committee (FOMC) considering labor market risks as a reason to cut rates.
The first area of concern is the underperformance in household survey employment growth, which fell short of payroll growth by 0.7 million jobs in 2023 and by 1.4 million jobs so far in 2024. However, the household survey is known for its higher volatility. Much of the recent discrepancy is attributed to the household survey not capturing the recent surge in immigration, and further compounded by the variability in employment among the 16-24 year-old demographic.
“Our estimate of underlying trend job growth based on the optimal combination of payroll and household employment remains at a solid 200k jobs per month, well above our 125k estimate of the go-forward breakeven rate,” the economists said in a note.
The second weakness is a 0.4 percentage point increase in the unemployment rate on a three-month average basis, a rise that is broad-based across various industries. Sectors such as information and goods transportation, which had become somewhat overstaffed, contributed to about one-third of the overall increase. According to Goldman, this suggests that some of the unemployment rises may be due to temporary frictional unemployment as workers are reallocated in response to significant shifts in demand composition in recent years.
The third concern is the decline in the hiring rate to levels below those seen before the pandemic. Analysis across industries and states indicates that this decline in gross hiring was primarily driven by a reduction in quits, leading to fewer departing workers needing replacement.
“The low rate of turnover can be seen as a weak spot, but so far it is not a major problem for most workers. New entrants to the labor force are the exception—their job-finding rate is now quite low,” the economists noted.
Compared to three previous instances when the Fed cut rates outside of a recession, the current labor market conditions are stronger than at the time of the first cuts in 1995 and 1998 but are similar to circumstances in 2019. Still, the labor market has been softening more rapidly than in those past episodes, the note states.
Although this softening has largely been a necessary normalization so far, continued broad-based softening at the recent pace would likely be seen unfavorably by the FOMC.
The decision to cut rates has historically been most influenced by the unemployment rate and jobless claims. While some Fed officials have emphasized the importance of closely monitoring these indicators, most remain less concerned so far.
“For now, the Fed’s decision on whether or not to cut in September hinges mainly on the next three rounds of inflation data. But moderate further labor market softening could make downside risks a more central part of the case,” said Goldman.