No love of labor: Why the US labor market needs some preventative medicine

Introduction: Welcome to Eyes on the Economy by CIBC Capital Markets, a podcast series dedicated to addressing current issues in a concise format, helping to make sense of the evolving economic complexities, so that you can take action.

Ali Jaffery: Welcome to the latest edition of Eyes on the Economy podcast. I’m Ali Jaffery, Executive Director and Senior Economist at CIBC. And today I’m joined by the man, the myth, the legend, our Deputy Chief Economist, Benny Tall. How’s it going, Benny?

Ben Tal: Excellent, how are you doing Ali?

Ali Jaffery: I’m doing great, excited for this one. so Benny, we just put out a paper on the US labor market, how things look right now and some of the causes of the weakness. So why don’t you kick us off here by walking our listeners through what are your thoughts about the US labor market and where is it headed?

Ben Tal: Yes, that’s a very good question. And I think, by the way, it was a very good paper that we wrote. Just if I can say that. Listen, I think that there is a tug of war between the labor market and the GDP numbers. You know, every first Friday of the month at 8.30 in the morning, we get the employment numbers from the US. 8.30 in the morning, first Friday of the month. So at 8.29 in the morning, every economist is sitting in front of his computers, looking, waiting, anticipating the numbers. Believe me, it’s very exciting.

Ali Jaffery: Agreed. That’s right.

Ben Tal: And we’re looking at the US numbers. And of course, there is this tug of war between GDP and the labor market data. GDP looks good. You know, second quarter GDP was better than expected. It was revised upward. All of a sudden, income is up. All of a sudden, we discovered overnight that Americans are better savers than we thought. And the third quarter GDP, think, Ali, will be even better than expected. So clearly, GDP is telling you one thing. So why the Fed is cutting at all? The reason is that GDP numbers are very bad in capturing in recession. You go to 91, you go to 2001, you go to 98. In all cases, the recession started, the Fed did not know that. Why? Because GDP numbers, the first estimate of GDP numbers were actually positive and then they were revised downward. So GDP is not telling you where you are. You look at the labor market in 2008, in 91, in 2001, they were down already which we saw the labor market is a better indication of a turning point in the economy and that’s why the focus should be you on the labor market and that’s why we wrote this piece. And if you look at the labor market, nothing to write home about. You look at the probability of becoming unemployed rising. You look at the probability of staying unemployed rising. In fact, at the level that we have seen only in recessions, you look at the quiz rate, you know, getting down significantly. You look at all kinds of other leading indicators in the labor market, nothing to write home about. And one more thing, all those numbers that we are getting that are not so great, are being revised downward. Now, yes, we got a September numbers that was better than expected, but nothing in economics is linear. Otherwise, you can put the monkey as the head of the Fed when nothing will happen. I’m saying it’s not linear. Clearly, it’s slowing down in my opinion. And it will slow down even more because those numbers will be revised. Very important for investors to understand what’s happening. In the payroll survey, there are three rounds. The first round, they go to the employers and ask a question. And what we are seeing more and more and more is that the response rate from small businesses is much lower than it used to be. Now, small businesses are not doing any hiring, they are doing a lot of firing. This is the weakest segment of the economy. So in the first round, you’re actually not sampling the weakest segment of the labor market. And that’s why the first round is actually better than perceived. And then the second round is being revised downward. Since the beginning of 2023, Ali, 80 % of all revisions were downward. I believe that will continue to be the case in the turning point of the economy. That’s important. So whatever number you get, it will not be the final number and the final number will be actually weaker than that. Which means in my opinion, the labor market is weaker than perceived. That’s one thing to look at. And then we have the issue of profit margins. We know that during COVID, many retailers were hiding behind the fog of supply chain. Remember Ali, you went to the store, you asked for this dishwasher and they will say, you know. Supply chain.

Ali Jaffery: I remember that.

Ben Tal: China, India, but if you pay a bit more, if you pay a bit more, we’ll find one for you in the basement. Listen, there was a high correlation between supply chain issues and profit margins among retailers. Now supply chain is basically back to normal, no other place to hide, and profit margins are now rising by zero. However, the level is still extremely elevated, and the big question is, Ali, and that’s something that you dealt with in your portion, is what will be the response curve from

Ali Jaffery: Yeah.

Ben Tal: CEOs, you have two options. One is do nothing. The other is do something in order to maintain those margins. And that’s something that I would like to discuss with you.

Ali Jaffery: That’s kind of where we move from your part of the analysis, which showed very clearly the labor market is softening, it’s cooling. And one of the big reasons that our research found that firms have invested a lot in technology and productivity. see an association, a positive association between the increase in unemployment across sectors and the cumulative investment in intellectual property products. softened R &D since the pandemic. So there’s some link between higher investment in technology and higher productivity. And also we saw that firms, the type of labor that they selected also has changed. The composition of job vacancies has tilted more toward the public sector versus the private sector. know, retail, for example, which is a very labor intensive sector. its share of overall vacancies has declined significantly, even though the level of vacancies is roughly speaking, normalizing or close to back to normal. And the type of worker, firms are selecting people with more leadership managerial experience who have professional skills as opposed to point of service type workers or administrators. you the labor demand is shifting and the type of worker they want is changing. And yes, population aging is a part of that, population aging has been happening for a while and we’ve seen that sort of accelerate as the different waves of baby boomers have retired. But that doesn’t really explain all of those, that reallocation that we’ve seen in the labor market, which we kind of document in the piece.

Ben Tal: So the quality of employment is actually rising and will be rising.

Ali Jaffery: Yes, and so what’s the challenge with that quality of higher employment is that that higher quality is more expensive and comes back to your point here about margin. So what firms have done is they invested a lot in productivity, so they don’t need to expend as much on the labor side, and because they need to retain these margin gains, which they saw no increase over the pre-pandemic period. And so why continue to add labor? I think that’s why we’re worried that the labor market isn’t going to turn a corner or just stop and stay where is now. Firms need to retain this increase in margin that they’ve seen in the post-pandemic. They’ve done it on the productivity side, but to keep that going, they can’t keep adding expensive and highly-scaled labor. The other part is that, ironically, one part that’s supporting margins right now artificially is their net interest expenses. So, interest rates have risen and firms in response have stopped borrowing. the commercial lending has kind of flatlined and that’s how they’re artificially supporting more margins. So as rates come down, they’re going to likely borrow more because they need to invest in more kind of tangible investment. So that too will crimp their margins. So they really don’t have a lot of room to maneuver other than passing on prices, which clearly they don’t want to do, or cutting back on labor and that will simply mean just not hiring as much anymore.

Ben Tal: Absolutely, and I think that’s a major issue for the consumer. You have the labor market slowing down, you have the excess savings basically reaching zero, you don’t have the buffer that until now was supporting and protecting the consumer. So we have an issue and that’s why quite frankly, Ali, my bias is for a weaker US economy then perceived. I think that our call is that November, December 25, 25 going down to a terminal rate of about 3.5. I think if there will be a bias there, will be downward. I think that the economy might surprise on the downside. And that’s why I think that the bond market is cheap. The long end of the curve is very cheap, I think that there is a lot of money to be made in this environment, given the weakness of the US economy in general. So that’s the way I see the situation.

Ali Jaffery: I’m not as, a little bit as pessimistic as you. yeah, I agree that, you know, as we documented, the labor market is going to soften. That I agree. I’m just a little bit puzzled by how strong the consumer has been, and on the income side that we saw those massive revisions that are mostly due to asset income. So that gives them a little bit more run room. So I, but what I can see is this bit of divergence between GDP and the labor market, persisting for a little bit longer. And that’s going to be challenging for the Fed. But I think ultimately they’re going to land on what you’re saying is that they’re going to put more weight on the labor market and the risk to GDP that emanate from that. But it’s interesting that, I think a lot of people have discounted the role of asset income and supporting consumption in the US economy. That’s been one of the big changes I think in the post pandemic. And that sort of makes sense with, baby boomers retiring and continuing to live, you know, a very comfortable lifestyle. So there will be a little bit of a wedge that’s going to cause some problems at the US GDP growth. The potential rate could be much higher now. I kind of strongly believe that given the revisions and that we had an average growth rate of around 3 % for two years. So I know a lot of that is from these productivity enhancements that show up in a variety of different ways, including the asset market and consumer spending. So it’s a complicated picture in the US, but certainly the labor market is softening and I think it’s heading in that direction. The Fed will cushion that. And our call right now is three and a half, as you mentioned. We’ll see how it unfolds over the next few weeks. But yeah, we have quarter point cuts in November and December. But Benny, let’s get the people what they want. You know, let’s get to real meat of the issue here. For those of you who don’t know, Benny is an avid basketball fan and he’s been talking to me a lot about his NBA Finals predictions. So let’s give the people what they want, Benny. Who’s going to win the NBA Finals this year?

Ben Tal: Well, it’s coming from an economy, so it must be, you know, accurate. Listen, I think it would be Dallas versus Boston. I think Dallas is extremely talented. Thompson is actually adding a lot of fire there. And I think that Boston is extremely deep. My prediction, Boston.

Ali Jaffery: There you go everybody, you heard it here first, Boston Dallas MBA finals, there you go. So with that, I think that’s a good place to stop and I encourage our listeners check out our note on our website and we thank them for joining us on today’s podcast. Until next time, we’ll have our eyes on the economy and we’ll be calling it as we see it.

Outro: Please join us next time on the Eyes on the Economy where we will share our latest perspectives and outlook for the Canadian and US economy.

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