• Cautious Recovery

    The Cautious Recovery

    The Cautious Recovery

    “Hofstadter's Law: It always takes longer than you expect, even when you take into account Hofstadter's Law.”

    -Douglas Hofstadter, from "Gödel, Escher, Bach: An Eternal Golden Braid"

    Jobs Friday is the data junkie’s favorite day of the month, with enough fuel for weeks of commentary. Estimates for nonfarm payrolls for August were right in line with expectations with a gain of 1.4 million jobs.

    In keeping with Hofstadter’s Law, it’s looking like this recovery is going to take longer than many hoped. That 1.4 million jobs added in August was helped by 238,000 temporary Census workers hired by the federal government. Private payrolls rose only 1 million, down from a gain of 1.5 million in July and 4.7 million in June. At August’s pace, it would take a year before all the jobs lost are recovered, and that’s if the pace of hiring doesn’t continue to slow as it has.

    The longer the recovery takes, the higher the risk that this unique lockdown recession turns into a more traditional recession. The unemployment rate continues to fall as more workers come off temporary furloughs, but the percentage of people becoming permanently unemployed is rising. Quickly.

    Put this chart in the K-shaped recovery pile. Workers returning from furlough is certainly a positive, but the re-employment of millions seems to be masking a more traditional recession forming underneath.

    On top of that, many of those sectors bringing workers back and fueling the job recovery seem to be slowing. If the hardest-hit sectors, such as food services and drinking places, which was up 134,000 in August compared to an increase of 525,000 in July, are indeed slowing re-hiring, a prolonged period of heightened unemployment is likely.

    The key to recovering those remaining 2.3 million food service jobs, in the absence of a vaccine, is figuring out how to open safely. If you’ll excuse a rare fit of optimism, that does seem to be happening.

    Since Aug. 12, restaurant traffic has moved from a decline of 55% year over year to a drop of 39% at latest, while the COVID positive test rate has declined from 8.1% to 7.7%. Higher activity with a lower COVID infection rate is 2020’s holy grail, and we appear to be — finally — navigating that righteous path.
    It won’t surprise you to learn that food service hiring tracks restaurant activity pretty tightly (analysis!). Assuming the improvement seen in data from the hotel reservation service OpenTable holds, expect September to show many more than the 133,000 restaurant jobs added in August. A simple forecast based on recent correlations suggests we could see over 1 million reclaimed jobs for restaurant and bars alone in the current month’s report, though it’s still early.

    How might the Federal Reserve have viewed Friday’s labor market report? Let’s use last week's data to discuss the recent change in Fed’s policy framework as it relates to their employment mandate. Folks, prepare for some Fedspeak:

    On maximum employment, the [Federal Open Market Committee] emphasized that maximum employment is a broad-based and inclusive goal and reports that its policy decision will be informed by its "assessments of the shortfalls of employment from its maximum level." The original document referred to "deviations from its maximum level."

    We’ve emphasized the important change above. Simply put, the Fed is downgrading the importance of the non-accelerating inflation rate of unemployment, or NAIRU, which is the minimum level unemployment can reach without causing inflation. The mythical NAIRU can’t be seen, can only be estimated, and the Fed has spent a decade revising it downward when no price pressures could be found.

    OK, maybe that wasn’t so simply put. Even more simply put: If there aren’t clear signs of inflation, the Fed won’t be calling unemployment “too low.” And it certainly won’t be preemptively raising rates in anticipation of future inflation. The Fed’s Lael Brainard has suggested that the committee has learned its lesson on this front.

    “The longstanding presumption that accommodation should be reduced preemptively when the unemployment rate nears the neutral rate in anticipation of high inflation that is unlikely to materialize risks an unwarranted loss of opportunity for many Americans … had the changes to monetary policy goals and strategy we made in the new statement been in place several years ago, it is likely that accommodation would have been withdrawn later, and the gains would have been greater.”

    The other component to the change in the Fed’s framework that jumped out at us was that the maximum employment mandate is a “broad-based and inclusive goal.” The Fed for years has been trying to point to broader measures than the headline unemployment rate to measure unused labor capacity. Now it is official policy.

    Below are a couple examples of broad-based and inclusive measures of labor market slack. The traditional unemployment rate is officially known as the U-3 measure. The U-6 measure of unemployment includes those working part-time who want full-time work and so-called discouraged workers who have given up trying. Back in the previous recession, the spread between U-3 and U-6 showed millions on the edge of the labor market, who then eventually found work as conditions improved much later in the cycle. The same trend is shown in the more inclusive measure of the Black versus white unemployment rate, which took just as long to recover.

    More traditional monetary policy rules would have suggested the Fed start hiking interest rates much earlier than they did during the recovery, while these more broad-based measures were still suggesting exorbitant slack in the labor market. That was essentially confirmed by the delayed spurt in wage growth, which did not surpass the low bar of 3% until late 2018 as these broader measures of slack converged with the headline rate. The change in its guidelines suggests the Fed will wait even longer in the future before removing stimulus, with the single rate replaced by this composite view.

    Fed Chairman Jerome Powell has been outspoken about the importance of broadening the mandate. We’ll close with a quote from him, speaking about the previous economic expansion and the importance of making monetary policy more inclusive:
    “Moreover, as the long expansion continued, the gains began to be shared more widely across society. The Black and Hispanic unemployment rates reached record lows, and the differentials between these rates and the white unemployment rate narrowed to their lowest levels on record.

    As we heard repeatedly in our Fed Listens events, the robust job market was delivering life-changing gains for many individuals, families, and communities, particularly at the lower end of the income spectrum. In addition, many who had been left behind for too long were finding jobs, benefiting their families and communities, and increasing the productive capacity of our economy.”

    The Week Ahead …

    There will be no speeches from the Fed next week as members enter a quiet period ahead of the Sept. 15-16 meeting, during which the committee is contemplating the option of offering additional forward guidance.
    The holiday-shortened week will also see less economic data. Most significant is the release of estimates for small business confidence in August via the National Federation of Independent Businesses' survey, as well as the results of the Bureau of Labor Statistics's "Job Opening and Labor Turnover Survey" for July. Both provide cross-sections of the labor market to give more detail into the slower pace of hiring we've seen since June.