May Payrolls: A Hodgepodge Labor Market
Stronger May payrolls growth vs. subdued job-finding rates vs. a declining labor supply means a hodgepodge labor market. Wage growth picked up notably.
Today’s release of the May Employment Situation report suggests a hodgepodge labor market, with payrolls growth picking up, unemployment rising as the job finding rate remains subdued and labor supply contracted, and wage growth accelerating. None of this will result in the Fed changing policy rates soon.
Key takeaways:
Payrolls growth momentum picked up and trends continue to run above the breakeven pace needed to keep the unemployment rate constant.
The unemployment rate hit 4% as the labor force participation rate dropped from 62.7% to 62.5%. The immigration impulse on labor supply is now past its peak and is clearly fading at this point.
The job-finding rate fell over the month to below 50% but smoothed trends remain around 50%, a level were entries and exits in and out of unemployment are broadly balanced.
Wage growth rose, with momentum in composition-adjusted average hourly earnings turning away from the pace consistent with 2% inflation.
Today’s data will not sway the Fed’s focus away from the inflation data to determine the start date of rate cuts.
May Jobs Growth: Acceleration
The May jobs report released today indicated that payrolls in the establishment survey surprised to the upside as they were up by 272,000 persons in May, compared to a weaker 165,000 increase in the preceding month (which was revised down from 175,000 initially). Payrolls growth for March and April combined were revised down by 15,000 persons.
The breadth of payrolls growth has been a concern amongst Wall Street commentators and opinion makers alike. Compared to April, more sectors expanded their payrolls, thus expanding the breadth further (chart above)1.
In terms of headline numbers, the unemployment rate increased 0.1 percentage point to 4% in May. In three-digit terms the unemployment rate went up from 3.865% in April to 3.964%. Household employment contracted in May: from +25,000 persons in March to -408,000 persons. Meanwhile, the labor force also declined by 250,000 persons, while the pace of population growth in May equaled +185,000 persons resulting in a lower labor force participation rate at 62.5% relative to 62.7% in April. As the number of persons leaving the labor force in May (+433,000) essentially matched the decline in household employment, most of the unemployment rate increase appears to be due to labor supply dynamics.
As can be inferred from the chart above, the immigration component of the labor force participation rate peaked in March and since then has been declining. So, the immigration impulse on the labor force is now clearly fading, and with native-born labor supply remaining stable below pre-COVID levels, the labor market is unlikely to provide any further supply side improvements for the economy.
The chart above compares the job growth signals from the establishment and household surveys, and it shows the excess volatility of the household survey relative to the establishment survey, with the former mean-reverting back to the latter relatively soon after big household survey moves in either direction. In May employment growth from the household survey again moved sharply in the opposition direction compared to the establishment survey, which means notable upside risk to the outlook of household employment growth, and thus unemployment rate, in the coming months.
Moving beyond the month-to-month movements, the chart above shows three- and six-month moving averages of payrolls changes from the establishment survey since January 2022. The underlying pace of job creation in the U.S. economy slowed through October 2023 but since then the pace of payrolls growth picked up again. With smoothed trends in payrolls growth within the 240,000-260,000 persons range, payrolls growth remains well above the breakeven pace needed to keep the unemployment rate at 4% over the next 6 months (purple dashed line in the above chart).
Additional details about the underlying strength of the labor market can be inferred from the household employment survey. Following Shimer (AER, 2005), we can use data on total unemployed and employed persons as well as the number of people that are unemployed for less than 5 weeks to estimate:
Job-finding rate: the probability an unemployed person in month t will find a job or leaves the labor force. This is calculated assuming that total unemployment in month t+1 equals month t unemployment plus the number of people unemployed for less than 5 weeks in month t+1.2
Job-separation rate: the probability an employed person in month t will either loses its job, quits or retires, which depends on data on the job-finding rate, unemployment and employment.3
The chart above shows a plot for the estimated job-separation rate. This job-separation rate has been relatively stable over the past two year, with a moderate downward shift in the first half of 2023 that stabilized between June and October. Note, however, that the chart above also makes clear that the variability in the separation rate has been really modest.
Since October job separations have ticked up (chart above), and over that period we saw the labor force participation rate declining from 62.8% to 62.5%. Job separation rates remain below those seen in 2022, but they are edging closer to those levels.
The job-finding rate declined a lot after Q1 2023 (chart above) and fell from a probability a person no longer is unemployed in a given month equal to around 55% in early 2023 to close to 45% by the summer. Given the earlier discussed decline in job-separation rate over the same period, this likely reflected a significant decline in hiring by firms as the supply of workers increased. However, since the summer the job-finding rate recovered and commenced an uptrend with the probability a person leaves unemployment in a given month rising to about 54% on the month and 52% on a three-month average basis in December.
In 2024, however, the job finding rate eased again. In May the total unemployed number of persons grew more than the number of newly unemployed persons (less than 5 weeks in duration): +157,000 vs. +47,000. This suggests that it became harder to exit unemployment between April and May, resulting in a drop in the job-finding rate to about 48% in April from 50% previously (chart above). Three- and six-month averaged job-finding rates in April remained around 50%, which suggests that the labor market is close to a steady state were entries and exits in and out of unemployment are broadly balanced.
A Pickup in Wage Growth
Average hourly earnings of all private sector employees grew over the month in April by 0.4% month/month, notably up from 0.2% in April, and also increase substantially in year/year terms from 3.2% in March to 4%. For production and non-supervisory workers, hourly earnings were up 0.5% month/month in May, up from 0.2% in the previous month, and on a year/year basis they jumped from 3.4% to 4.2% in May.
The wage data from the jobs report are notoriously noisy, given that they are revised often and do not correct for the sectoral and skills composition of jobs growth over the month. There are better quality wage data available, such as the Atlanta Fed Wage Growth Tracker and the Employment Cost Index, but the Atlanta Fed does construct a rudimentary composition correction for average hourly earnings from the jobs report, which can be found here.
We can observe from the chart above chart that the easing in wage growth in April was likely an outlier. In May, corrected wage growth rates firmed back up to around 4%.
When I combine labor productivity and labor share trend estimates with the 2% inflation target, along the lines I do in my usual monthly “Wages and Inflation Expectations” note and incorporating the Q1 update of productivity data, the May medium-run annual wage growth rate consistent with 2% inflation is at about 2.5% (purple line in the above chart). The Fed will be not pleased with the May composition-adjusted average hourly data, as the downward momentum in April clearly is not sustained, reversing any progress towards the inflation target-consistent pace of wage growth.
The Fed Will Not Cut Rates This Summer
The May FOMC rate decision made clear Fed that is willing to be patient to assess the sustainability of the disinflation that has occurred. Especially so given the recent firming in spot core services inflation data. The above discussed labor market developments for May will not convince the Fed to change its focus on the incoming inflation data to assess the right time to start easing.
It is going to take a while for the Fed to commence with rate cuts, given the sharp drop in core prices disinflation observed up to now and it will need to see sustained evidence of a slower wage growth. The decline in the labor supply seen in May suggests this might well take a long time. A move towards policy rate cuts will not happen in H1 2024; the September FOMC meeting is the earliest point in time to expect a Fed funds rate cut.
50 indicates an equal balance between industries with increasing and decreasing employment.
Given this calculation, the job-finding rate will run up to April utilizing data on (short-term) unemployment for May.
As the calculation of the job-separation rate depends also on (short-term) unemployment for May, we cannot go beyond April.