Labor Market Deterioration Likely to Prompt Near-Term Fed Rate Cut

Labor Market Deterioration Likely to Prompt Near-Term Fed Rate Cut 

In his latest Macro Roadmap, Goldman trader Cosimo Codacci-Pisanelli stated that a near-term Fed rate cut is more likely to result from a weakening US labor market than from changes in inflation. Fed Chair Jerome Powell shares this view, having mentioned after the May 1 FOMC decision that an unexpected labor market downturn could prompt earlier-than-expected rate cuts, despite seeing little chance of such an event at the time.

However, recent data, including today's disappointing JOLTS report and last month's poor nonfarm payrolls, suggest that this unexpected labor market deterioration might be occurring. This aligns with earlier warnings from March that US payrolls had been overestimated by at least 800,000, according to the Philadelphia Fed.

New data from the Bureau of Labor Services confirm that last year's nonfarm payroll numbers likely overstated job growth by about 730,000, with some months potentially showing job losses. These revisions are largely due to an increase in business closures and a slowdown in new business formations, which the payroll reports do not fully account for, as noted by Bloomberg's chief economist, Anna Wong.

When adjusting for these errors using the Quarterly Census of Employment and Wages (QCEW) numbers, it appears the true average monthly payroll increase in 2023 was only 130,000, significantly lower than the reported average of 230,000. Excluding distortions from erroneous "business formation" data, the current pace of job growth is even worse, potentially below 100,000 per month, a stark contrast to the reported three-month average of 242,000.

Bloomberg's Anna Wong predicts that if these inaccuracies remain uncorrected, the reported level of nonfarm payrolls for 2024 could overstate actual employment by over one million, with the majority of the discrepancy stemming from flawed business formation and closure estimates.

Political considerations might delay aggressive data revisions by the BLS before the upcoming elections. However, Bloomberg anticipates that in late August, initial clues about potential benchmark revisions covering April 2023 to March 2024 will emerge, potentially triggering a Fed rate cut in September.

Nonfarm payrolls, derived from a seasonally adjusted monthly survey of about 119,000 businesses and government agencies, are the most closely watched economic indicator. Last year, these payrolls consistently exceeded forecasts, cited as evidence of the economy's resilience to Fed rate hikes. However, more comprehensive payroll measures, such as the QCEW and Business Employment Dynamics statistics, suggest the labor market turned in the second half of 2023, with business closures rising and new business formations sharply slowing.

The Bureau of Labor Statistics' "birth-death" model, used for estimating business openings and closures, likely contributed to 300,000 of the 730,000 downward payroll revisions for 2023. Accurate data will reveal if job growth in October 2023, initially reported at 165,000 jobs added, might actually range from 84,000 to potentially below zero, indicating a possible recession start.

By year's end, cumulative nonfarm payrolls for 2024 may overstate true employment by more than a million jobs, with significant contributions from the birth-death model, as previously warned. Unfortunately, the true state of the economy may not be clear until well after the fact, with significant revisions expected post-presidential election.

Final data revisions for April 2023 to March 2024 will be published early next year, with potential clues emerging in late August, just before Powell's Jackson Hole speech. If these revisions indicate a significant overstatement of job numbers, it could prompt the Fed to cut rates in September.

In summary, if these estimates are accurate, they will challenge the notion that the labor market is strong while inflation falls. Instead, it suggests that inflation is decreasing due to a weakening labor market, adhering to traditional economic principles. The Fed's reliance on nonfarm payroll data might delay necessary rate cuts, potentially requiring more aggressive cuts later if the labor market continues to deteriorate.