The slightest of cracks in the US labour market

The latest non-farm payrolls (NFP) data on Friday showed ongoing resilience in the US labour market. To quote the president of the Federal Reserve Bank of Chicago, Austan Goolsbee, “the labor market seems to be stabilizing at something close to a full employment rate.” Is he right?

The much-anticipated NFP data for December showed 256k jobs created, well above consensus, while the two-month revision number was a minimal 8k (a welcome development following some of the recent larger revisions attributable to storms and strikes) and private payrolls were up an impressive 223k. The unemployment rate unexpectedly fell from 4.231% to 4.086% due to a strong 487k increase in the household survey, which surpassed the 243k increase in the labour force.

The US Federal Reserve (Fed) chair, Jerome Powell, regularly references the three- and six-month averages for NFPs; the latest numbers leave the former unchanged at 168k (accounting for last month’s slightly lower revision) but raised the six-month average to 164k from 141k. Clearly a strong trend, inclusive of revisions, and data which the Fed will look favourably upon.

Tuesday’s JOLTS data showed job openings increased to 8,098k in November, up from 7,839k in October and the third consecutive month of growth in this figure. Perhaps more surprising was a drop in leisure and hospitality openings (968k vs. October’s 1,0151k), given the recent pick-up in overall postings was driven by the professional and business services sector (1,885k vs. October’s 1,612k). It is interesting to see that labour demand is strengthening given monetary policy remains tight and political policy concerns are elevated. Stronger employer demand typically reflects confidence in economic growth – a need to meet rising demand for goods and services.

However, the quits and layoffs numbers paint a more intriguing picture. The quit rate for November dropped back to 1.9% from 2.1%. Typically this would align with reduced job openings, but it could still suggest a decline in worker confidence due to difficulty in finding another job. In addition, layoffs increased in November. While far from recessionary levels, higher layoffs can suggest businesses are becoming more cost-conscious or adjusting their workforce in anticipation of slower demand. Friday’s average hourly earnings (AHE) number also came in at 0.3% month-on-month, a slight reduction after two consecutive months at 0.4%; this is broadly in line with the trends noted above, though still a touch higher than what the Fed might be comfortable with in our view.

What does this mean for the Fed? While the labour market clearly remains strong – three months of rising job openings betrays little weakness – there are a couple of weaker signals that the Fed will be watching with interest in the context of potentially cooling wage pressures. A lower quit rate and rising layoffs reduce workers’ bargaining power, which could eventually dampen wage growth. This would help to ease inflationary pressures, particularly in the services sector where labour costs are a significant driver. This could be more prevalent in lower wage sectors like leisure and hospitality as labour demand moderates (note the drop in job openings for November).

However, Fed officials and markets will likely read stronger payrolls and a lower unemployment rate as clear evidence that the labour market is strong and stable enough to justify keeping the policy rate unchanged. With unemployment closer to the bottom of its recent 4.0-4.2% range, it will probably take several months of softer data to reassess this view. The Fed was already positioned for a pause in its rate cutting cycle at its January 28-29 meeting, and at this stage market pricing suggests another cut might not materialise until closer to year-end.

The market reaction to the stronger payrolls took US Treasury (UST) yields another step higher, which in and of itself is a form of tightening financial conditions and is bound to influence slower economic growth. The market is currently pricing just above one 25bp cut for 2025, and we feel this underestimates the number of cuts that will likely occur during the year. Let’s not forget that at this point last year markets were pricing in around seven cuts for 2024, which had fallen all the way to zero by Q2. Our base case anticipates rates could be cut to 3.75%-4.0% over the course of the year, particularly if we witness further progress on wage growth, where we anticipate lower quits and higher layoff ratios can play a role.

While the labour market currently appears strong, the tightening of financial conditions will have an impact on employer behaviour, and it was not so long ago that various market commentators were very worried about the rising US unemployment rate. We thought it was too early to declare victory on inflation in mid-2024, and similarly now we’d caution against declaring that the labour market is stable and at full employment.  

With 10-year UST yields approaching 5% we think duration is beginning to look more attractive again, but we certainly acknowledge the strength of the drivers that got us here. Wednesday brings US Consumer Price Index (CPI) inflation data for December – it promises to be another interesting day for rates.