Labor market strong, but normalization continues

Chief Economist Eugenio J. Alemán discusses current economic conditions.

The US labor market has remained relatively strong, but the trend over the last year or so has been one of normalization back to the pre-pandemic levels. One of the data series showing this normalization trend has been job openings. However, that series increased during the last two consecutive months of available data, in October and November of 2024, after hitting a cycle low of 7.4 million in September of last year. The September 2024 data was also very close but slightly below the pre-pandemic cycle high. Although this consecutive increase may be temporary noise in this series, which tends to fluctuate considerably, the fact that it is now much higher versus the pre-pandemic cycle’s high may be once again an indication that the labor market continues to surprise on the upside.

At the same time, the current nonfarm payroll number continues to be extremely strong compared to the historical average even if it has also weakened considerably during the last year. Average monthly nonfarm payroll in 2024 was about 186,000, compared to a historical average of about 125,000 per month (if we include recessions in the calculation and 220,000 if we exclude recession periods) going back to 1939.

One of the reasons for this strength seems to be related to structural changes that have occurred with new business formations, which have skyrocketed since the pandemic recession and have not come back to pre-pandemic levels. We conducted several structural tests that showed, in fact, that there was a structural break in this series in 2020, but more specifically in April of 2020, which corresponds with the break in the series in the graph below. The Bureau of Labor Statistics calculates the number of jobs that will potentially be created by these new businesses and that seems to have increased the estimated contribution to new nonfarm payroll jobs coming from the ‘birth-death’ econometric models.¹

In summary, there is a long lag period between when new firms are created and when they first start reporting new employees as well as when the BLS adds them to the sample. Furthermore, these issues take on a larger role when the economy faces such a big crisis as was the case during the COVID pandemic when so many businesses went out of business and then, when the crisis ended, as shown in the graph above, so many new businesses were created compared to the past. Thus, we have to expect that the model estimations are probably overstating the strength of the US labor market as shown by the large downward revision reported last year. However, if this is the case, it is almost impossible, at this time, to know how much these numbers are overestimated. If there are no structural changes in this data, then we should see some normalization in these numbers going forward. However, for now, new business formation data seems to indicate that Americans are creating more businesses today than they were creating before the pandemic recession and the expectation is that these new businesses are creating more jobs today than in the past.

Robust Employment in December 2024, Higher Inflation Expectations in January 2025

Employment ended the year with a bang as the nonfarm payroll number showed the US economy added another 256,000 jobs during December for a total addition of 2.2 million jobs or about 186,000 per month, while the rate of unemployment declined slightly, to 4.1% compared to a 4.2% rate in November. The strength in employment creation was broad-based in the service-providing industry. At the same time, it declined in almost all of the goods-producing sectors except construction and nondurable manufacturing.

The strength in employment in December accompanied by a preliminary increase in long-term inflation expectations from the Consumer Sentiment reading, the highest reading for this indicator since June of 2008 (see Consumer Sentiment indicator on page 9). We want to note that the release in the sentiment index is the preliminary number for January and we will need to wait to see if the final number is revised when it is released at the end of the month. Markets, of course, did not like these two numbers and have reacted negatively, with the stock market plunging in the early hours of trading and the yield on the 10-year Treasury continuing its upward momentum. It is clear that the strength in economic growth, the strength in employment, as well as higher inflation expectations, especially in the long run, are not good news for monetary policy and the path of interest rates during this year. Although the year is still young, the recent increase in petroleum and gasoline prices is definitely making an impact on Americans’ expectations of inflation. Thus, Federal Reserve officials will probably tread carefully when deciding on the future path of interest rates.

¹ For more information on the business births deaths model see this BLS resource in sections “Business births and deaths,” “Net birth-death model,” “Forecasting net birth-death employment,” and “The net birth-death model and seasonal adjustment” for a more technical explanation in the following webpage: https://www.bls.gov/opub/hom/ces/calculation.htm#business-births-and-deaths

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Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

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Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.

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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.

Employment cost Index: The Employment Cost Index (ECI) measures the change in the hourly labor cost to employers over time. The ECI uses a fixed “basket” of labor to produce a pure cost change, free from the effects of workers moving between occupations and industries and includes both the cost of wages and salaries and the cost of benefits.

US Dollar Index: The US Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the

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Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.

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Producer Price Index: A producer price index(PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.

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Source: FactSet, data as of 12/6/2024