The labor market is beginning to cool down

Stocks rallied strongly on Friday after some weaker economic numbers kicked in the “bad is good” buying reflex. Employment is softening… but just by a little bit, which may not be enough to cause a change of heart at the Federal Reserve.

Services required. Remember way back at the beginning of the pandemic. Come on, you remember the tumbleweeds rolling through your downtown’s Main Street. I remember walking through the streets of New York where I could count more rats than people milling about. You know that is not exactly true, but I did manage to spot more rats than usual during those early pandemic days. The reason for the post-apocalyptic scene was, of course, the lockdowns to prevent the spread of deadly COVID-19. Hardest hit were restaurants, hotels, travel, and entertainment venues. Even doctors, dentists, hairdressers, manicurists, personal trainers… massage therapists were negatively impacted by the lockdowns. All the people that work in those professions fall into the services category. That is where the most layoffs occurred at the beginning of the pandemic. In fact, some 17.1 million service jobs were lost in April 2020 alone. Total job losses for that month were around 20.5 million, so the bulk of the layoffs were in the services area, as you might expect. By the summer, some scant signs of life began to pop up. Some businesses found ways to safely conduct business, though on a significantly smaller scale. That meant that some workers were able to return to their posts. The biggest single monthly rehiring spike in services came in June of 2020 in which some 4 million service workers were hired, respectable but still a minor amount relative to the total service jobs lost in the first quarter. You may not have known these exact numbers, but surely, you would have suspected that this was the case.

Since then, the services sector has recovered considerably. Restaurants have reopened, hotels are fully booked, planes are flying, and, thankfully, hairstyles are… um, stylish once again. Despite these businesses all reopening, they have all been struggling to fill job openings. With so many service workers out of work, you would assume that it would be simple to fill vacancies, but it hasn’t. Not only has the lack of workers put a strain on productivity, but it has also put a strain on margins. HOLD ON, “what does that mean, Mark, and why are you bringing this up,” you ask? When companies struggle to fill vacancies, they are forced to raise wages to incent workers to join, and higher payroll expenses eat into margins. You know what comes next. Price hikes and inflation. That’s right, in order to maintain healthy margins, companies will raise prices to compensate for higher expenses. I have written a lot about the tight labor market and how the Fed is very concerned about it, particularly in the… you guessed it, services sector. We have heard from FOMC members talking about how they would like to see a softening in the service sector before they could be comfortable that inflation has been licked. If we look closely at the inflation figures we can see that goods prices are slowly easing in contrast to service prices which continue to climb. The Fed has made the connection between service labor market tightness and service inflation. Interestingly, if we looked back at 2021 and 2022, you would see that the bulk of the monthly hiring came from the services sector, which makes sense considering the amount of job losses that occurred at the start of the pandemic. Check out the following chart, which breaks down the month change in Nonfarm Payrolls over the past 2 years. The bright orange bars represent lower paying service jobs and the green bars higher paying service jobs. High level, however, the chart shows that overall hiring is slowing, which may be negative for the economy, but positive for inflation… at least according to the Fed, and it is the Fed that is in control of interest rates. The final bar in the chart represents last Friday’s Nonfarm Payrolls release, which showed a month over month decline. This was a factor in Friday’s rally. Also contributing to Friday’s rally was the ISM Services Index which came in at 49.6, below expectations. Index readings below 50.0 indicate a contraction. Want to give a guess when the last time the index was in contraction territory? In April and March of 2020. This will surely catch the eye of Fed policy makers.

FRIDAY’S MARKETS

Stocks rocketed higher on Friday after Nonfarm Payrolls came in lower than the prior month and ISM Services Index showed a contracting services sector. The S&P500 gained +2.28%, the Dow Jones Industrial Average climbed by +2.13%, the Nasdaq Composite Index jumped by +2.56%, and the Russell 2000 Index traded higher by +2.26%. Bonds gained and 10-year Treasury Note yields fell by -16 basis points to 3.55%. Cryptos advanced by +0.49% and Bitcoin added as much.

NEXT UP

• Today’s Fed speakers: Raphael Bostic and Mary Daly.
• The week ahead: Earnings season starts! Additionally, we will get the much-awaited Consumer Price Index / CPI and University of Michigan Sentiment. Check out the attached earnings and economic calendars for times and details.