Predicting a labor-market downturn was never an easy task. But unique post-pandemic dynamics are making it even harder for economists to determine whether a recent uptick in the unemployment rate is signaling trouble ahead.
Monthly employment data due Friday will probably add fuel to the debate. Unemployment has risen in each of the last three months and is now close to triggering a recession indicator developed by former Federal Reserve economist Claudia Sahm that has a perfect track record over the last half-century.
Other traditional early-warning measures, like temporary-help employment and the quits rate, have also been flashing warning signs. But many forecasters see a case for interpreting the recent deterioration in those metrics as a return to normal as the red-hot job market of the pandemic recovery starts to cool.
“This is not a traditional business cycle. This is a cycle where we are coming out of a very different type of environment,” Michael Reid, a US economist at RBC Capital Markets. “The rate of change can be rather deceiving, just because of that yo-yo effect that you get coming out of Covid.”
Unemployment rose to 4.1% in June, up from the low of 3.4% reached in early 2023. Economists expect Friday’s numbers to show it remained there in July — at least temporarily arresting the upward trend — even as payroll growth moderated, according to the median estimates in a Bloomberg survey. Still, the recent increase in the jobless rate has raised the temperature in the debate over where interest rates should be.
Fed Chair Jerome Powell was asked Wednesday about the so-called “Sahm rule” during a press conference after he and his colleagues decided to leave their benchmark rate unchanged at the highest levels in more than two decades. He said what policymakers “think we’re seeing is a normalizing labor market,” though if “it starts to show signs that it’s more than that, then we’re well positioned to respond.”
The US central bank is now widely expected to begin easing in September. But a number of prominent economists in recent weeks — including former Fed Vice Chair Alan Blinder, Goldman Sachs Chief Economist Jan Hatzius and former New York Fed President William Dudley — argued the case for an earlier move, in part due to the latest developments in the labor market.
Benign Interpretation
A more benign interpretation of the recent rise in unemployment goes like this: Immigration was severely restricted and millions of Americans left the workforce during the pandemic, artificially depressing the unemployment rate. Participation rates have since rebounded as those trends have reversed, meaning the unemployment rate is drifting back to rates that would have otherwise prevailed.
Sahm herself said last week that a surge in the number of people entering the workforce is “likely overstating” the extent to which the labor market is softening, arguing in a July 26 newsletter that “the Sahm rule is currently sending the right cautionary message about the labor market cooling, but the volume is too loud.”
The story is similar across other indicators like vacancies, which have fallen by nearly a third since reaching a peak of 12.2 million two years ago. Despite the striking rate of change, at 8.2 million, openings continue to hover substantially above pre-pandemic levels. The same is true for unemployment insurance filings, which despite a recent pickup remain historically low.
“This pandemic era has been one in which so many apparent rules have been flouted,” Powell said Wednesday. “Many, many pieces of received wisdom just haven’t worked, and it’s because the situation really is unusual.”
One thing is clear: Workers have lost the rare upper hand they enjoyed in recent years as the economy was rapidly recovering from the initial shock of Covid-19. The share of job openings per unemployed person looking for work fell to 1.2 in June — down from a nearly 2-to-1 peak in early 2022. Those job-seekers are now taking longer to find a new gig, and the pace of wage growth is almost back to the pre-pandemic status quo.
“Recession thresholds crossed or not, we’ve seen a real cooling off in the labor market,” said Sarah House, a senior economist at Wells Fargo & Co. “The direction of travel is not favorable right now.”
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