What You Should Look For In This Week's Jobs Report
The fate of the next Federal Reserve decision will be decided on Friday.
If the monthly Nonfarm Payrolls number is “strong,” then another rate hike should be expected, bringing the upper end of the Fed policy range to 5.5%. However, if the monthly jobs number is “weak,” then the FOMC will probably stay on “pause.”
The chart below shows that the 3-month average of monthly job gains is slightly less than 300,000, a robust pace of job creation by most assessments.
We all know employment is a highly lagging indicator, and thus changing interest rates based on any given monthly number is far from optimal policy, but there is quite a bit of information within the report if the data is processed carefully.
In this update, I’ll review how I look at several different “buckets” of employment and how by studying the economic cycle sequence, we can gain a much more informative picture of the underlying economic trends rather than crafting a story based on one number.
Cyclical Vs. Non-Cyclical Employment
The economy follows a predictable sequence of events. The lead and lag time of the sequence varies from cycle to cycle, but the sequence remains the same in inflationary or disinflationary periods.
This sequence is why each cycle rhymes.
Studying this sequence can provide more information about the underlying trends as compared to analyzing the entire economy from one signal number.
Whether we are looking at the GDP report, or the employment report, we can break the economy into three segments:
• Cyclical Economy
• Total Economy
• Non-Cyclical Economy
The chart below shows this analysis for the labor market, plotting the growth rate of Cyclical Employment, Total Employment, and Non-Cyclical Employment.
Cyclical Employment is the sum of construction and manufacturing, and Non-Cyclical Employment is the difference between Total Employment and Cyclical Employment.
There are three key points to take from the above chart.
The first is that the sequence is always the same. Red line, blue line, then black line in terms of falling into contraction ahead of recessionary periods.
The second key point is that Total Employment, the blue line, is highly lagging, often turning negative several months after the recession begins.
Lastly, is that the growth rate of Cyclical or Total Employment that triggers a recession is different each time.
For example, let’s take a look at the 1974 scenario. The recession started in December 1973 when Cyclical, Total, and Non-Cyclical Employment growth were all +3%!
As the recession started, Cyclical Employment growth cracked first (as always) and still did not show a marked contraction until more than six months into the recession.
Today, we see somewhat of a similar trend in terms of the labor market lagging the broader economy and a splintering of Cyclical Employment growth vs. Non-Cyclical Employment growth.
Zooming in on today’s labor market picture should cause more concern than it has so far, as most people stay focused on the headline or topline numbers.
After November 2022, as monetary policy started to bite in the interest rate-sensitive sectors, there was a clear crack in the Cyclical and Very Cyclical Employment categories.
Many investors suggest that Cyclical Employment doesn’t matter because the economy is mostly Services (Non-Cyclical), but that statement doesn’t hold true based on recent recessionary data.
Except for the COVID recession, which needs to be excluded for obvious reasons, the Cyclical Economy has lost more jobs than the Non-Cyclical Economy in every recession, including the 2008 crisis.
The headline NFP number will offer virtually nothing in terms of information about the future direction of the economy nor the current underlying trends, which always proliferate through the Cyclical or interest-rate sensitive sectors first.
This chart shows the 3M average change in Cyclical Employment, Total Private Employment, and Non-Cyclical Employment.
There has been a very significant drop-off in Cyclical jobs creation, particularly at the start of 2023.
Monetary policy has clearly started to work through the economy and we can see visible stress emerging in the Cyclical sectors of employment, always where the signs show up first.
The Federal Reserve is not willing to take the directional signals that come from this historically reliable sequence, which greatly increases the risk of a very hard landing as monetary policy will overtighten based on lagging indicators.
The earlier movers in the sequence imply monetary policy has certainly done enough to cause a crack in Cyclical sectors. While aggressive rate cuts may not be prudent under inflationary uncertainty, the case for additional rate hikes with ongoing Cyclical job losses is equally as nonsensical.
Summary
So what should you look for in this week’s jobs report?
While the Fed and the overall market will have a knee-jerk reaction to the headline number, it’s worth paying attention to the story that emerges from the economic cycle sequence.
You should break the jobs report into several buckets based on the level of Cyclicality.
If we see more weakness in the Cyclical Employment baskets, we know with a higher level of confidence that recessionary conditions are biting, and there is grave business cycle risk imminently ahead.
However, if the Cyclical Employment sectors do not show an increasing pace of deterioration, then that could certainly prolong the onset of the recession.
In either case, a comprehensive overview of Leading Indicators suggests that completely avoiding a recession is historically improbable, but the story from the economy’s most Cyclical sectors will help understand the question of timing.
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