Economic Commentary

More signs of labor market cooling: Weekly Economic Review & Outlook

August 07, 2023
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July’s employment report showed a continued downward trend in hiring, but the job market remained very tight as evidenced by a 3.5 percent unemployment rate and rapid wage growth. Also in last week’s economic data, the July ISM surveys continued as they have been in recent months, with manufacturing mired in contraction and services continuing to expand at a solid pace.

Key Takeaways:

What we learned last week: (pg. 1)

Downtrend in job growth continued in July

Although job growth in July was virtually even with June, the three-month moving average fell to its lowest level since January 2021.

Expansion persists in service sector

With manufacturing still contracting, the service sector continues to do the yeoman’s work to keep the economy out of recession.

What we’re watching this week: (pg. 2)

August 10: Consumer Price Index

Headline inflation likely rose with energy prices spiking

The headline consumer price index (CPI) for July should see a 0.3 percent increase, in part due to the spike in gasoline and other energy prices at the end of the month. Core consumer inflation should post a smaller 0.2 percent increase with housing costs expected to decelerate and used car prices likely to drop sharply. While year-on-year inflation slowed to 3.0 percent in June, it is likely to move higher again in July given the decline for the CPI a year ago. Service sector inflation, although easing somewhat, has remained elevated and consumers are expected to continue spending on services into the third quarter.

August 11: Producer Price Index

Producer costs increasing again with uptick in energy prices

Wholesale inflation continued its rapid decline in June as year-over-year growth in the producer price index (PPI) fell to its lowest level in nearly three years. Due to rising energy prices and a tough comparison from the decline in the index a year ago, we’re expecting a faster 0.3 percent increase for the headline index in July. Still, the core rate (the overall rate less food and energy) likely climbed by only 0.1 percent during the month — equal to the slower pace for input prices in previous months. This would mean core PPI inflation should fall from 2.4 percent in June to 2.2 percent in July.

August 11: University of Michigan Consumer Sentiment

Sentiment likely to edge lower in early August

Consumers have demonstrated remarkable resilience despite heavy headwinds of high inflation and rising interest rates. Most households remain cautiously optimistic of economic conditions, led by the strong labor market and rising incomes. After spiking in July, consumer sentiment survey is expected to pull back modestly in the first half of August, partially reflective of higher gasoline prices. Still, inflation expectations should continue to ease as consumers see the light at the end of the tunnel for cost increases.

Analysis: Further slowdown in job gains

After revisions, the monthly change in payrolls for July of 187,000 was essentially unchanged from June (the second straight month under 200,000). Health care led the way in July, up more than 87,000, while total manufacturing employment has been flat since April. While not a weak report by any means for a late-cycle month, the three-month moving average for job gains fell to 218,000, the slowest pace since early 2021, as hiring in many sectors has clearly slowed.

The market remains tight, however, as the unemployment rate dipped back to 3.5 percent. Reflecting this, average hourly earnings climbed by 0.4 percent for the month and continued to rise at a buoyant 4.4 percent on a year-over-year basis. The 12-month growth rate has run above 4.3 percent all year and remains well above the pre-Covid pace of 3.0-3.5 percent. This continued pressure on wages is not consistent with a 2.0 percent core inflation rate. Chairman Powell has underscored that wage growth would need to slow to around 3.5 percent (trend productivity growth plus inflation) to be in line with an eventual return to normal for inflation. Incomes should be slower in July, however, as the average workweek fell 0.1 hours resulting in growth in average weekly payrolls (the proxy for personal income) of just 0.2 percent.

There was little in the July employment report to alter the Fed’s hawkish lean, especially the upside surprise for earnings. Fed officials will want to see the August employment report and the next two monthly CPI readings before deciding whether they can hold steady in September or if further rate hikes are required to cool labor demand and inflationary pressures.

Analysis: Services continue to drive growth in the economy

The ISM manufacturing index edged higher in July, although it remained well below 50 and has been in contraction for nine straight months. Still, sector conditions have leveled off with new orders and production both moving higher in July. All major sub-indices show modest contraction, leading to negative growth for most manufacturing industries, but this level of contraction would not be enough to pull the broad economy into recession without services following suit.

On that note, the ISM services index pointed to continued modest expansion, led by further demand from consumers. The employment index downshifted, but this may have been due to the inability to hire enough workers rather than much easing of employer demand. Worryingly, the prices index moved higher in July, highlighting the sticky nature of services inflation across the economy.

The ISM Composite Index, which combines the two sector readings according to output, remained modestly above the 50 expansion/contraction line in July.  As long as spending of services remains buoyant, the overall picture for business sector growth should be positive, helping to move the economy forward despite higher interest rates from the Fed. The solid start to the third quarter for job gains is another sign that the long-expected recession continues to be delayed.

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