Job growth picked up by 559,000 in May, notably stronger than the solid, yet disappointing, 278,000 increase in headcount estimate for April, but the real story is that the strong recovery in demand is being held back by supply constraints, especially in the labor market. So, the market remains concerned that inflation might increase on a sustained, not a transitory, basis.
The leisure and hospitality industries are leading the rebound in hiring, even as headcount in these categories remain well below pre-pandemic levels. Nonetheless, actual hiring lags far behind job openings. People are returning to eating out at restaurants and public events in droves, in many cases beyond the ability of firms to handle the rising crowds. Reservations are tougher to make, reduced staffing curtails service, and prices are higher. Firms are trying to hire, as most restaurants now sport help wanted signs in their windows and pay is rising more rapidly. But getting back to “normal” is proving difficult. Average wage rates for the leisure and hospitality sectors increased by 2.8% over just the past two months, or 16.7% at an annual rate, a clear indication of how aggressive employers are to bring back workers. More such increases are likely in the coming months, since the labor supply constraint isn’t likely to loosen until after Labor Day (if then).
An intense debate exists over the causes of the lack of labor supply, despite a 5.8% unemployment rate. The extra $300 per week unemployment payment is widely thought to encourage some workers to remain home, since their unemployment benefits exceed the income they’d earn if they returned to work. The pandemic almost certainly induced some baby boomers to retire early. And some people might still be reluctant to return to work until the number of Covid cases recede even further. But perhaps most importantly, many parents can’t return to work until schools reopen. These deterrents may not ameliorate until after Labor Day, although roughly 40% of all states will terminate the extra $300/week unemployment payment by the end of this month.
What is clear is the labor market is not behaving as if there is a large number of unemployed clamoring for work, as would be expected with a 5.8% unemployment rate. The inconsistency is apparent from the pace of wage inflation. Some people have noted that there are still roughly 7 million fewer people working today than pre-pandemic. Yet, firms are having great difficulty filling jobs. Since these conditions are likely to remain in place at least until Labor Day, wage inflation is likely to remain high. When does this flow through into prices?
Avoiding the flow through of wages into prices is critical to the Fed’s intention to keep its current highly accommodative strategy in place. In fact, some senior Fed people have already expressed that they are thinking about when the Fed should start to taper the bond buying program, even as they support continuing it. Logically, the case for the Fed’s buying mortgage securities makes little sense when the entire industry suffers from lack of supply and bidding wars. But the Fed did announce this past week they would be selling off its corporate bond and corporate bond ETF holdings. At just over $13 billion, that’s a trivial amount relative to its monthly purchase of $120 billion in Treasuries and mortgages, yet the Fed intends to sell those positions over the balance of the year, presumably to avoid any ripples in the bond market. Nonetheless, it is a start to tapering.
The economy is likely to continue its strong recovery in the coming months, even as labor scarcity acts as a headwind to growth and a tailwind to rising labor costs. Q2 GDP growth is likely to be in the ballpark of 10%, a simply massive number and Q3 should also be quite strong. With that kind of growth, it is easy to imagine that inflation pressures could develop that would easily exceed the Fed’s target and tolerance. The bond market rallied on Friday, taking joy that job growth undershot projections, so the Fed is unlikely to begin tapering its bond purchases in the very near future. Even so, we see the risk as asymmetric, especially if labor costs continue on their current path.