The Week Ahead – Labor Market Muddle

Welcome to “The Week Ahead” where we take a moment to provide our thoughts on what we can expect in markets and the economy during the upcoming week.

Last week a family friend told us about a well-known fast food restaurant by her house that was closed due to their inability to hire enough workers. Ironically, the data show that the unemployment rate is still high at 5.9% with seven million workers still displaced by the pandemic. In addition, job openings are at record highs with more than nine million job openings. All these conflicting dynamics beg the question: Is the labor market tight, or is it loose? The answer is both.

There are essentially four reasons for the disequilibrium we are currently seeing in the U.S. labor market.

• Supply has fallen as some workers have withdrawn from the labor force. Those at particular risk to Covid-19 are unlikely to return until the pandemic is fully resolved. The Federal Reserve Bank of Dallas estimates that 2.6 million people have retired since the start of the pandemic.
• Enhanced unemployment insurance benefits. The Biden administration’s fiscal stimulus package included a supplemental $300-per-week unemployment benefit. This means that some workers actually earn more by staying unemployed.
• Many parents have decided to stay home to take care of young children who have not been able to attend school in person.
• There is a skills mismatch. The sectors of the economy that have soared during the unprecedented recession (e.g. housing) require a set of skills that a worker that was employed in hospitality may not have. Over time, this dynamic will adjust as both workers and employers reassess that value of work, and workers learn new skills.

Two of the four factors are short-term in nature. The federal enhanced unemployment benefit ends this September, while many states have already chosen to eliminate additional support to motivate the labor pool to return to work. Once schools start up in the fall, the childcare shortage will also become less of a consideration.

The reason why the labor component to the economy is so important is that it, more than anything else, is the key to the inflation outlook and the timing of the eventual withdrawal of monetary policy support by the Federal Reserve. One of the reasons capital markets have remained quiescent has been due to the Fed’s explicit rhetoric that they have decided to prioritize the full employment part of their dual-mandate above stable prices.

If workers are in chronic short supply, wage inflation will continue to climb, and that will result in higher prices as businesses pass along higher costs. In economics, we call this demand-pull inflation, which is the upward pressure on prices (wages) that follows a shortage in supply, a condition that economists describe as too many dollars chasing too few goods (workers). Wages tend to be sticky since workers expect compensation to increase over time; i.e. higher wages are here to stay. It will be interesting to see just how “transitory” inflation ends up being as workers command more bargaining power than any time in a generation.

This week we see a lot of interesting economic data. Retail sales likely remained strong in June while gasoline sales are up sharply as prices continue to move higher due to increasing demand. We estimate unemployment claims fell to 350,000 for the latest week. Furthermore, June industrial production advanced +0.6%. Manufacturing production likely posted only a modest gain, but utility production (electricity) surged, in large part from the hot weather. The Consumer Price Index (CPI) was probably up +0.5% in June, which translates into a +4.9% annualized gain with gasoline prices fueling much of the increase.

Data deck for July 12–July 16: