The BLS announced that payroll employment climbed 339,000 in May. The private sector added 283,000. The bulk of the gain was in the service sector, adding 257,000. The goods sector increased 26,000 but almost all of it, 25,000, in construction.
Although employment climbed 339,000, average weekly hours fell from 34.4 to 34.3 (a decline of 0.1%), throwing a little cold water on the overall report. As shown in the chart below, average weekly hours have trended down since late 2020. Hourly pay, however, climbed 0.3%, from $34.33 to $34.44, and the year over year increase was 4.30%; unfortunately, that growth is still a bit below the year-over-year CPI inflation rate for April, 4.96% (the May CPI has not yet been released).
The household data showed almost exactly the opposite from the establishment survey with an employment decline of 310,000. The employment to population ratio fell slightly from 60.4 to 60.3, and still falls below the pre-pandemic level of 61.1.
The unemployment rate is based on data from the household survey. As mentioned above, employment fell by 310,000 according to the household survey. Combined with a 440,000 increase in the number of unemployed persons, the unemployment rate rose from 3.39% to 3.65%. The changes in the number of employed and unemployed left the labor force participation rate unchanged at 62.6%.
To be “officially” classified as unemployed, an individual must have “actively” looked for a job and available to begin employment. This definition excludes those who are deemed “marginally attached” to the labor force who would like a job, but have not taken sufficiently active measures to find one. The chart below plots the headline unemployment rate along with a measure that includes marginally attached individuals as well as those employed part time for economic reasons (the “U-6” definition). Whereas the headline unemployment rate is 3.7%, the broader measure of unemployment stands at 6.7%. The gap between the two, 3.0%, is about as low as it has been since 1994 when the U-6 measure of the unemployment rate starts.
Until the early 1980s, female unemployment tended to exceed that of men; since then, the pattern has reversed. Since 2021, the male unemployment rate has exceeded that of women by 0.17 percentage points.
Note: We use the terminology of the BLS so as not to add any confusion, in particular, Sex and Race. Also, the BLS uses the terminology Race and Hispanic or Latino Ethnicity.
Historically, Black and African American unemployment rates have exceeded that of other racial groups. Since 1973 (when the data becomes available), the Black and African American unemployment rate has averaged 6.1 percentage points higher than that of whites. Over time, this gap has narrowed; since 2021, it has averaged 3.1 percentage points. Hispanic and Latino unemployment rates lie between that of Blacks/African Americans and whites. (Note that we have seasonally adjusted the Hispanic and Latino unemployment rates using Python’s ARIMA X11 package with default settings; officially seasonally adjusted series are not available.) Over the available data, the Hispanic/Latino unemployment rate exceeded that of whites by 3.15 percentage points; since 2021, by 1.5 points. The Asian unemployment rate is only available since 2003. On average, their unemployment rate is 0.55 percentage points lower than that of whites; since 2021, the gap is only 0.09 points.
We can further look at unemployment rates by sex and race, albeit for those 20 years of age and older. As mentioned earlier, since the early 1980s, for the population as a whole the male unemployment rate has exceeded that of women. While the same is generally true for Blacks/African Americans and whites, the average unemployment rate for Hispanic/Latino women is 0.95 percentage points higher than that of Hispanic/Latino men. Data for Asians is not broken down by sex.
People enter unemployment through various channels. The largest component is for people who lose their job, that represents about half of all of the unemployed. The next largest category is from those who reenter the labor force after a spell of being absent; these are labeled reentrants. Then there are those that voluntarily leave their jobs and those who are just entering the labor force.
Looking across those unemployed, average weeks of unemployment has been trending up somewhat over time. Between 1950 to 1980 average weeks of unemployment hovered between 10 and 15 weeks. Indeed, average weeks never hit 20 weeks until after 1980. Since that time average weeks have hit 20 or more numerous times and today stands at just over 21. The Great Recession and the pandemic had massive effects on weeks of unemployment.
Overall, the labor market continues its strong performance. While the unemployment rate increased it still remains as low as the economy has seen for decades.
The BEA announced that Q1 real GDP increased 1.1% at an annual rate. Many in the press have, obviously, noted the declines over the last two quarters indicates the economy is slowing. Indeed, today’s report “undershot” expectations that were around 2%. However, the underlying components were a bit more mixed and the strength of the economy might be in the eye of the beholder. Real consumption spending increased 3.7%, the largest increase over the last 7 quarters, and disposable personal income rose 8.0%.
The output identity, Y = C + I + G + X – M, tells us the uses of output (the “demand” side). If output growth is down, then one or more of the right-hand side components must be down. From above, consumption growth rose from 1.0% in the fourth quarter to 3.7% in the first quarter. Growth in government spending likewise rose, from 3.8% to 4.7%. However, real investment spending fell 12.5% in the first quarter compared to a 4.5% increase in the fourth quarter. Within real investment, real inventories grew 0.4% (up from -3.7%), non-residential structure investment grew 11.2%, and residential structure investment fell by 4.2% (although this decrease was an improvement over the very negative growth rates for this category late in 2022).
While it has become standard in the U.S. to annualize the quarterly growth in GDP, one could also look at the year-over-year growth rate. Now, Q1 does not look so bad relative to the past few quarters and, in fact, has actually increased over the previous quarter.
The Personal Consumption Expenditure Price Index (PCE) rose 4.2% in the first quarter compared to growing 3.7% in the previous quarter, obviously high above the FOMC’s 2.0% target.
These developments lead to a murkier monetary policy outlook. Output growth has slowed, perhaps reflecting the cumulative effects of monetary policy tightening over the past year. Yet, PCE inflation is still well above the Fed’s 2% target (see also the CPI and PPI), and consumption growth actually accelerated in the first quarter. In previous posts, we have noted that the labor market is still quite strong, with an historically low unemployment rate, and roughly two job openings for every unemployed person. Given that, there is nothing new to dissuade the FOMC from another rate hike or two.
The BEA announced a downward revision from 2.7% to 2.6% in the third and final estimate of Q4 GDP. The revision primarily reflected downward revisions to exports and consumer spending. The final estimate for 2022Q4 GDP did not change the overall stance of the US economy.
Several sources picked up on the fact that the PCE price index, the primary inflation index cited by the Fed, fell. CNBC reported: “On a 12-month basis, core PCE increased 4.6%, a slight deceleration from the level in January.” The New York Times remarked,
The measure of inflation most closely watched by the Federal Reserve slowed substantially in February, an encouraging sign for policymakers as they consider whether to raise interest rates further to slow the economy and bring price increases under control.
The Personal Consumption Expenditures Index cooled to 5 percent on an annual basis in February, down from 5.3 percent in January and slightly lower than economists in a Bloomberg survey had forecast. It was the lowest reading for the measure since September 2021.
NYT, March 31, 2023
However, as we remarked in an earlier post, measured inflation is sensitive to the time horizon over which it is computed. Annualized month-to-month inflation rates are quite volatile; year-over-year inflation is much smoother, but is slow to reflect changes in trend inflation. And it’s trend inflation that policymakers, among others, are concerned about. Yet, identifying trend inflation is difficult. One approach is to average monthly inflation rates over a few months. In the figure below, we include the 3-month average of monthly inflation rates which is our attempt to balance the desire to smooth monthly inflation rates while capturing changes in trend in a timely fashion.
The Fed tends to focus on so-called core PCE inflation for which the volatile food and energy components are removed. Presumably, the reason for looking at core PCE inflation is that it gives a better read on trend inflation. To be sure, core PCE inflation is less volatile, as shown in the chart below. Nonetheless, this measure continues to exhibit large fluctuations when measured on a monthly basis. And, it should not be surprising that the annual (year-over-year) inflation rate is smoother, but slow to reflect changes in trend inflation. Again, we include the 3-month average of monthly inflation rates.
One way to think about the problem of extracting a measure of trend inflation from the data is that observed inflation is composed of trend inflation and an ‘error’ which reflects issues in measuring trend inflation. In the jargon of the profession, we face a signal extraction problem: we are trying to extract the signal (trend inflation) from noisy data (measured inflation). Averaging monthly inflation rates over some horizon (for example, over 3 months, as above) can be thought of as canceling out the positive and negative error terms in this signal extraction problem. (Again, using some jargon, ideally the errors are uncorrelated over time, or independently and identically distributed.)
Finally, what are the policy implications of the latest PCE price index numbers? As mentioned above, some commentators have noted that PCE inflation was down in February relative to January. True enough when looking at either the monthly inflation rate, or the year-over-year inflation rate. However, the 3 month average inflation rate is up. It is hard to make a strong case that there has been a change in trend inflation. In any event, all of the gauges of inflation presented above continue to run well above the Fed’s stated 2% target.
The BEA announced that the advance estimate for Q4 GDP came in at 2.9% after increasing 3.2% in Q3. Personal consumption expenditures remained pretty stable, increasing 2.1%, contributing about 1.4 percentage points of the total increase in GDP. The basic message being that recessionary fears are somewhat allayed, at least for now.
While real investment increased 1.4% overall, the components were mixed. Investment in nonresidential structures increased 0.4%, the first rise in 6 quarters. Residential investment, however, fell for the seventh straight quarter, falling 26.7%.
The BEA also announced Personal Income and Outlays for December. The report showed that real personal income increased 0.2% from November to December while real personal consumption expenditures declined by 0.3%. The PCE price index rose 0.1% over the month and core PCE rose 0.3%.
Labor Market
The BLS announced the employment situation showing payroll employment increased 517,000, and, as per usual, crushed the estimates that hovered around 190,000. The report, along with a strong December continued a robust labor market in 2022 after coming through pandemic-related turmoil. Pre-pandemic employment stood at 152,504,000 in February of 2020. The pandemic created a massive decline, down to 130,515,000 in April of 2020; a decline of 21,989,000 (17%) in just two months! The decline rapidly reversed, however, and by January, 2022 employment stood at 149,744,000, about 2% lower than its February 2020 level. Since January of 2022 employment has increased by about 4,000,000 and now stands at 153,743,000.
The bulk of the increase in the January data was in the service sector, rising 397,000. The information sector lost 5,000 jobs for the second straight month. Information employment saw a large fall in employment starting around the beginning of 2000 and another large dip during and after the Great Recession, in total, that sector lost about 1,000,000 jobs during that period. Since then, the information sector has gained back about 500,000 of those jobs and now has roughly 3.1 million workers.
Average weekly hours of work shot up from 34.4 to 34.7. This, accompanied by the 517,000 increase in employment, led to about a 15% increase in total hours of work in the US, far surpassing any increase over the last couple of years.
Also just released by the BLS was the preliminary estimate of Q4 non-farm productivity. Output per hour rose 3.0% with output rising 3.5% and hours of work rising 0.5%.
The recent JOLTS showed that the number of job openings increased in December, now standing at just over 11 million, that is, about 2 job vacancies per unemployed individual. It is certainly clear that this is one of the strongest labor markets ever seen, at least since the unemployment data began in 1948.
Inflation as measured by the Consumer Price Index (CPI) was down, again, in December. The monthly change for the CPI in December came in at -0.079% after increasing 0.096% in November and 0.44% in October. The year over year change in December was 6.42% following 7.12% in November and 7.76% in October. (Since we use seasonally adjusted CPI data, our annual inflation rates differ slightly from the headline numbers that use unadjusted data.) In fact, since July the monthly annualized inflation rate consistently ran below the annual inflation rate, as shown in the figure below. Roughly speaking, the annual inflation rate is the average of the previous 12 months’ inflation rates. As a result, when the monthly inflation rates are below the annual inflation rate — as has been the case in the second half of 2022 — the annual inflation rate will fall. Conversely, when the monthly inflation rate exceeds the annual inflation rate, the annual inflation rate will rise, as it did between July 2020 and June 2022. This discussion implies that it will take another six months of low monthly inflation rates until the annual inflation rate will be reported to be low.
At this stage, it’s helpful to take a step back and ask: What exactly do we mean by “inflation”? In general, inflation refers to an on-going increase in the general level of prices. Operationally, inflation is typically measured by the percentage change in a price index like the CPI, Core CPI (the CPI excluding its more volatile food and energy components), or the Personal Consumption Expenditure (PCE) price index, to name but three. As shown in the next figure, over long horizons, these three measures of inflation tend to move together.
A couple of issues arise. First, over what horizon should inflation be computed? Since inflation is an ongoing process, monthly inflation rates don’t do the trick since they’re far to volatile (see the first chart above). While annual inflation rates are much smoother than their monthly counterparts, annual inflation rates are slow to reflect changes in trend as in the second half of 2022. A simple rule like “Use a three or four month average of the monthly inflation rates” is tempting, but arbitrary. It is, perhaps, best to look at both annual and monthly inflation rates and apply some judgement.
A second issue is that a once-and-for-all increase in the price level is not really “inflation” in the sense of a continuing increase in the price level. However, the (annual) inflation rate as computed from, say, the CPI will record higher inflation following such a one-time change in the price level. Indeed, such a change in the price level will lead to an increase in reported inflation for 12 months. The relevance of this second issue is that the war in Ukraine pushed up global food and energy prices. To the extent that these price increases are permanent, they do not contribute to inflation (on-going increases in prices), although they raise measured inflation. To be sure, core CPI inflation (that is, stripping out the food and energy components) has been lower than overall CPI inflation. Comparing the monthly inflation rates for the CPI and core CPI reveals that monthly core CPI inflation is less volatile. In the event, at least some of the increases in food and energy prices owing to the Ukrainian war have proved to be temporary. Falling food and energy prices in the second half of 2022 have contributed to the decline in monthly CPI inflation. As shown in the chart below, monthly core CPI inflation continues to run well above the Fed’s stated 2% inflation target.
A Quick Primer on Price Level Measurement
The idea of inflation measurement is to uncover a general rise in prices in an economy. The two that garner the most attention, the Consumer Price Index (CPI) and the Personal Consumption Expenditure Index (PCE). The Bureau of Labor Statistics (BLS) calculates the CPI (see the technical note here):
The Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services. The CPI reflects spending patterns for each of two population groups: all urban consumers and urban wage earners and clerical workers. The all urban consumer group represents about 93 percent of the total U.S. population. It is based on the expenditures
of almost all residents of urban or metropolitan areas, including professionals, the self-employed, the poor, the unemployed, and retired people, as well as urban wage earners and clerical workers.
The CPI is a “cost of living” index as it uses spending patterns of urban consumers:
In calculating the index, price changes for the various items in each location are aggregated using weights, which represent their importance in the spending of the appropriate population group. Local data are then combined to obtain a U.S. city average.
The BLS also reports the “CPI less food and energy,” the CPI-X. The reason for omitting food and energy is that these prices are very volatile and have a large influence on the measure of the CPI because of the larger weights associated with them. For those interested, here are the current weights.
The PCE is calculated by the Bureau of Economic Analysis (BEA) that is also responsible for calculating GDP. According to the BEA:
BEA’s closely followed personal consumption expenditures price index, or PCE price index, is a narrower measure. It looks at the changing prices of goods and services purchased by consumers in the United States. It’s similar to the Bureau of Labor Statistics’ consumer price index for urban consumers. The two indexes, which have their own purposes and uses, are constructed differently, resulting in different inflation rates.
The PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and for reflecting changes in consumer behavior. For example, if the price of beef rises, shoppers may buy less beef and more chicken. Also, BEA revises previously published PCE data to reflect updated information or new methodology, providing consistency across decades of data that’s valuable for researchers. The PCE price index is used primarily for macroeconomic analysis and forecasting.
These are not the only two, however. The Cleveland Fed produces the median CPI and the 16% trimmed mean. Recall that the main idea is to capture a general rise in prices. Removing highly volatile changes, or outliers, better reflects this general rise. Note that the median measure has been stuck at 7% for the last three months.
The BLS announced December employment on January 6 with another solid month that continues to show one of the strongest labor markets in recent history. Payroll employment increased 223,000 overall and 220,000 in the private sector.
The service sector provided the largest increase, 180,000. Temporary help services fell 35,000 after falling 30,300 and 22,300 in the previous two months. On the goods side, construction and durable goods employment came in strong up 28,000 and 24,000, respectively; although nondurable goods employment fell 16,000.
Average hours of work fell to 34.3 from 34.4. The increase in employment and decrease in average hours worked have opposing effects on total hours worked. In the event, the decline in average hours worked dominated as total hours of work dropped for the second straight month.
The household survey showed an increase in employment of 717,000, once again showing a marked difference from the establishment survey.
The labor force increased 439,000 leading to an increase in the participation rate to 62.3. Moreover, the number of unemployed persons fell by 278,000. These changes led to a fall in the unemployment rate to 3.5%.
Overall, the labor market continues to show considerable strength. Consequently, any discussion of a recession needs to focus on other parts of the economy.
The BLS establishment data showed that payroll employment increased 263,000 in November. Combined revisions over the previous two months totaled -23,000. Private sector employment grew 221,000, led largely by the service sector that increased 184,000. While these changes are pretty much in line with the past several months, other parts of the report, except for wage growth, were not so positive.
Usually, when the BLS data are revealed, an increase in employment is thought to translate into an increase in output. However, average weekly hours of work fell to 34.4 after a five month string of 34.5. Overall, total hours of work (multiply average hours by employment) fell slightly from October to November. If output per hour remained the same between October and November, the decline in total hours means there will be less output. The BLS announced their productivity estimates for Q3 this morning, showing output per hour increased 0.8% from the previous quarter on an annual basis. While average hours from the employment report fell in the previous month, the BLS reports that both output and hours increased in Q3, 3.3% and 2.5%, respectively.
Average hourly earnings rose 0.55% in November. On a monthly basis, this was a large increase. However, as shown below, year-over-year inflation continues to outstrip year-over-year nominal earnings which means that real earnings have declined. While overall CPI inflation (year-over-year) has fallen in recent months, the same cannot be said of the CPI excluding food and energy (CPIX). This means that the recent decreases in CPI inflation can be attributed to falling energy prices — anyone who goes to the grocery store knows that food prices are up over the past year.
For the second month in a row, the household survey showed a decline in the number of people employed. In addition, the labor force participation rate fell for the third straight month, to 62.1. These changes ended up lowering the unemployment rate from 3.68% to 3.65%.
The takeaway from the latest data shows that the labor market remains strong although the establishment and household surveys give conflicting messages. Monetary policy appears to have succeeded in reducing inflation, despite continued high prices of both food and energy.
Many people have recently been debating whether, or to what extent, the US has fallen into recession territory. The latest GDP report shows strong overall growth…with some weak spots of course. Here is a detailed look at the report.
GDP and Components
On Thursday, October 27, the Bureau of Economic Analysis (BEA) released the advance estimate of Q3 GDP. After seasonal adjustment, real GDP increased 0.6% over from the previous quarter. “Real” means the quantity of goods and services, adjusting for the effects of price inflation. However, headlines touted a 2.6% growth rate for the U.S. economy in the third quarter. The difference is that the BEA (among others) expresses the 0.6% quarter-to-quarter growth rate as an annual rate, as if the economy grew 0.6% per quarter for four consecutive quarters. This solid real GDP growth comes on the heels of two consecutive quarters of decline – what some characterize as constituting a recession.
As many learned in their economics classes, there are several major components of output demand: consumption, investment, government spending and net exports, i.e., Y = C + I + G + (X-M). This identity is useful in identifying areas of strengths and weaknesses in the economy. To start, real consumption grew 1.4% (annualized) in the third quarter, down from a 2.0% growth rate in the second quarter.
Next, gross private domestic investment fell 8.5% – an improvement over the 14.1% decline in the second quarter. A well-known business cycle regularity is that investment is more volatile than consumption. This fact is borne out in the figures above and below, although the scaling of these figures, along with the extreme effects around the onset of the pandemic, partially masks this fact. Both residential and nonresidential structures investment have fallen for six consecutive quarters with the largest decline over that period coming in the third quarter, falling 26.4% and 15.3%, respectively.
Government spending grew 2.4% in the third quarter, after five consecutive quarters of decline. Keep in mind that government spending relates to expenditures on goods and services, and includes both “consumption” and “investment” components. Also, government spending excludes transfer payments that constitute a major component of government expenditures, but, for National Income and Product Accounts purposes, is spent by other entities, and so is not considered part of government spending.
Exports rose 14.4% with the export of goods rising 17.2% and services up 8.3%. Imports fell 6.9%. However, in the output identity above, imports are subtracted from output and so the decline in imports contributes positively to output. Since 2021, the U.S. dollar has strengthened against its trading partners. This strengthening of the dollar implies that imports have become cheaper for the U.S. while its exports are more expensive for its trading partners. In this light, the recent numbers for imports and exports presumably reflect considerations apart from relative price movements, such as changes in incomes. However, if foreigners wish to consume more US goods and services they must acquire US dollars and so both imports and the dollar can rise together. Over longer periods the relationship would more likely yield a negative correlation.
The output identity is also useful because it shows how output growth can be decomposed into contributions made by its major expenditure components. For example, the contribution of consumption is given by the growth of consumption weighted by consumption’s share of output. This calculation tells us that consumption contributed 1.0 percentage point towards the overall 2.6% growth in output. Large positive contributions were also recorded by exports (1.8 percentage points) and imports (1.4 percentage points). Meanwhile, investment dragged output down by -1.6 percentage points.
Final sales of domestically produced goods rose 3.3%. Disposable personal income grew 1.7%.
In terms of prices, the GDP deflator rose 4.1% in Q3 following a Q2 increase of 9.0% and Q1 of 8.3%. The personal consumption expenditures price index (PCEPI) increased 4.2% in Q3 following a 7.3% rise in Q2 and a 7.5% increase in Q1. While the consumer price index (CPI) is the price index most people are familiar with, the Fed mainly dwells on the PCE price index. The differences between the CPI and PCEPI are explained here…feel free to read if you like to know things like the CPI is a Laspeyres index while the PCEPI uses a Fisher-ideal index, among other things.
Employment Situation: Establishment Survey
The Bureau of Labor Statistics (BLS) announced that October employment rose 261,000 according to the Establishment Survey. August was revised down 23,000 while September was revised up 52,000. Employment gains were widespread with no major sectors showing any decline in employment. The private sector increased 233,000 and the largest single sector increase came in Services, rising 200,000. However, the 261k increase was the smallest since December of 2020.
Average weekly hours of work remained at 34.5 and average hourly earnings increased from $32.46 to $32.58. The year over year increase in nominal earnings is 4.72% so that inflation is still eating away at it and real earnings have actually fallen.
Employment Situation: Household Survey
The household survey showed that the number of employed individuals decreased 328,000, in stark contrast to the 261,000 increase in payroll employment. The employment to population ratio fell from 60.1 to 60.0.
The number of unemployed persons rose to 6,059,000 having increased by 306,000 over the past month, but there are still many more vacant jobs than those searching. The labor force fell by 22,000 with the participation rate declining from 62.3 to 62.2 and is still below the pre-pandemic reading. These changes led to an uptick in the unemployment rate from 3.49% to 3.68%.
For those who have been concerned that the U.S. has entered a recession, The Bureau of Economic Analysis’s October 27 release of its advance estimate for Quarter 3 real GDP brought good news: Output grew at an annual rate of 2.6%. This increase comes on the heels of negative output growth in the previous two quarters.
While two consecutive quarters of negative GDP growth are colloquially said to constitute a recession, there is no formal definition of a recession. The National Bureau of Economic Research (NBER) has a business cycle dating committee that (retroactively) determines the dates of entering and exiting a recession. The gray bars in the following figure are the recession dates as determined by the committee.
Recessions are recurring events that last for varying lengths of time. It appears that recessions were more frequent and lasted longer before the Great Depression in 1930’s than after. But what, exactly, determines entry and exit? The NBER states,
The NBER’s definition emphasizes that a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months. In our interpretation of this definition, we treat the three criteria—depth, diffusion, and duration—as somewhat interchangeable.
NBER Business Cycle Dating Committee
More concretely, the NBER looks at some key variables,
Because a recession must influence the economy broadly and not be confined to one sector, the committee emphasizes economy-wide measures of economic activity. The determination of the months of peaks and troughs is based on a range of monthly measures of aggregate real economic activity published by the federal statistical agencies. These include real personal income less transfers, nonfarm payroll employment, employment as measured by the household survey, real personal consumption expenditures, wholesale-retail sales adjusted for price changes, and industrial production. There is no fixed rule about what measures contribute information to the process or how they are weighted in our decisions. In recent decades, the two measures we have put the most weight on are real personal income less transfers and nonfarm payroll employment.
NBER Business Cycle Dating Committee
Based on recent behavior of the six variables, cited by the NBER, it seems difficult to build a case for a recession. In the figure below, data for 2022 is colored red to focus attention on recent history. To be sure, real personal income (excluding transfer payments) has been flat through 2022, but it has not fallen as it did in the 2001 and 2007-09 recessions. Employment as measured by both the Employment and Household surveys is at or above its pre-pandemic levels. While real personal consumption expenditures fell sharply during the pandemic, they have since returned to a trend line starting in the mid-2010s. Although real retail sales have been flat through 2022, they are nonetheless running above their pre-pandemic trend. Finally, since 2012, industrial production has fluctuated around a flat line, and is currently above its 2012-2019 average. In summary, there are no obvious red flags, and it seems difficult to imagine that the NBER will decide that the U.S. was in recession at any time in 2022 based on the data at hand.
Sources: Federal Reserve Bank of St. Louis, Bureau of Economic Analysis, and Board of Governors, Bureau of Labor Statistics
Interestingly, the media and other analysts talk quite a bit about some things left out of the above two measures. Stocks, housing and the yield curve among others. Forbes, for example, on October 19 says: The Yield Curve, A Reliable Recession Indicator, Just Sounded An Alarm. The Conference Board’s Leading Economic Index (LEI) includes these and other measures.
The ten components of The Conference Board Leading Economic Index® for the U.S. include: Average weekly hours in manufacturing; Average weekly initial claims for unemployment insurance; Manufacturers’ new orders for consumer goods and materials; ISM® Index of New Orders; Manufacturers’ new orders for nondefense capital goods excluding aircraft orders; Building permits for new private housing units; S&P 500® Index of Stock Prices; Leading Credit Index™; Interest rate spread (10-year Treasury bonds less federal funds rate); Average consumer expectations for business conditions.
Conference Board
Regarding the current outlook, the Conference Board states:
The US LEI fell again in September and its persistent downward trajectory in recent months suggests a recession is increasingly likely before yearend. The six-month growth rate of the LEI fell deeper into negative territory in September, and weaknesses among the leading indicators were widespread.
Ataman Ozyildirim, Senior Director, Economics, The Conference Board
US LEI declined further signaling an elevated likelihood of recession
The figure below presents many of the series that comprise the Leading Economic Index. We could not locate a publicly-available source for the ISM Index of New Orders; hopefully new orders for consumer goods captures similar information. Likewise, absent data for the Leading Credit Index, we used the Chicago Fed’s Financial Conditions Credit Index. In 2022, the stock market is down as are housing starts and consumer sentiment. The increase in the financial conditions credit index indicate a tightening of credit conditions, a worrying development, but its level is still relatively low. The spread between the 10-year treasury yield and the Fed funds rate has narrowed, but does not reflect an inverted yield curve. Although average hours in manufacturing are down relative to the pre-pandemic period, they have been quite stable for the past year and a half. Further, initial unemployment insurance claims have come down since the onset of the pandemic, and have stayed low; in past recessions, claims tend to rise during a recession. Finally, new orders for both consumer and capital goods have risen through 2022, and are at historically high levels. In total, the individual series underlying the Leading Economic Index give a decidedly muddled answer to whether the U.S. is either on the verge of recession, or already in the midst of one.
Sources: Federal Reserve Bank of St. Louis, Federal Reserve Bank of Chicago, Bureau of Economic Analysis, Board of Governors, Bureau of Labor Statistics, University of Michigan
Conventional wisdom holds that the yield curve inverts — short rates exceed long rates — prior to recessions. Above, the LCI looks at one particular measure of inversion: the 10-year treasury yield less the Federal funds rate (an overnight rate). The LCI’s approach is useful when looking at the behavior of the yield curve over time. However, the yield curve includes a variety of maturities, and the LCI misses this dimension. Below, we plot yield curves for U.S. treasuries for select days in 2022. Early in 2022, the yield curve had the usual upward slope, although the short end of the curve was quite flat. Over the year, the yield curve has risen, reflecting a rise in yields across maturities. However, the short end has risen by more than the long end. While the yield curve was still positively sloped in early July, by early August the one year rate exceeded those out to 10 years, and the 20 year rate exceeded the 30 year rate. The August pattern prevailed through September and October. To reconcile these observations with the yield curve summary measure in the LCI, notice that the shortest maturity in the yield curves figure is one month while the LCI uses an overnight rate, the Federal funds rate.
Source: U.S. Treasury
Historical empirical regularities — such as, the yield curve inverts ahead of recessions — are likely to fall apart when relevant conditions change. In the case of the yield curve, what changed was the Fed’s Quantitative Easing program, and now unwinding. Exceptionally, Quantitative Easing saw large scale purchases of long term treasuries by the Fed. The figure below serves as a reminder that until the 2007-08 Financial Crisis, treasuries with maturities over five years constituted a small fraction of overall Fed treasury holdings; by 2013, they were the majority. While the share of longer term treasuries has since declined, they are still a much larger proportion of the Fed’s treasuries portfolio.
Source: Federal Reserve Bank of St. Louis
Looking at the changes in the Fed’s treasury holdings by maturity gives some idea of the magnitude of the Fed’s interventions in treasuries markets. The figure below reports monthly changes in the Fed’s portfolio of treasuries, calculated from the reported weekly changes. And we group the changes in the Fed’s portfolio into short (under 1 years maturity), medium (1-5 years maturity) and long maturities (over 5 years). The increases in overall Fed holdings of treasuries in 2009, 2011, 2013 and 2020 can be seen as increases in both short and long maturity treasuries. While it seems curious that between 2014 and 2018, large increases in the Fed’s holdings of short maturity treasuries were largely offset by decreases in its holdings of long maturity treasuries, this is not our current focus.
Source: Federal Reserve Bank of St. Louis
By reducing the supply of long maturity treasuries available to the public, the Fed pushed up the price, thereby lowering the yields on long maturity treasuries. In other words, Quantitative Easing likely flattened the yield curve when the Fed was actively accumulating long maturity treasuries.
The figure below zooms in on 2022. Starting in April, the Fed reduced its holdings of medium term treasuries. For reasons just discussed, these actions tend to increase medium term treasury yields. In the first half of 2022, the Fed accumulated both short and long maturity treasuries, thereby lowering their yields. The net effect of these changes in Fed treasury positions is to push up the `middle’ of the yield curve while pulling down the shot and long ends. In September and October of 2022, the Fed has reduced its holdings of short, medium and long maturity treasuries which serve to raise rates at all maturities, thereby raising the yield curve. The Fed may have good reasons for the observed changes in its portfolio of treasuries. The point is simply that these actions have likely introduced noise into whatever signal is coming from the shape of the yield curve.
At this point, readers may sympathize with U.S. President Harry Truman’s wish for a one-handed economist. There are, of course, many who attempt to boil the state of the economy down to a single number. For example, Jeremy Piger at the University of Oregon uses a dynamic-factor Markov-switching model first developed by Marcelle Chauvet at the University of California at Riverside, to determine the probability of being in a recession. Piger writes:
Monthly smoothed recession probabilities are calculated from a dynamic-factor Markov-switching (DFMS) model applied to four monthly coincident variables: non-farm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales.
Jeremy Piger
To determine whether the model is good at predicting a recession, Piger then says:
Historically, three consecutive months of smoothed probabilities above 80% has been a reliable signal of the start of a new recession, while three consecutive months of smoothed probabilities below 20% has been a reliable signal of the start of a new expansion.
Jeremy Piger
Piger’s model produces the following graph, showing that as of August, 2022, the probability of a recession is just 1.22%.
Piger’s model lines up pretty well with the NBER recessions save for a couple notable exceptions. The NBER called a recession in March of 2001 but according to Piger’s model the recession probability never reached 50%. Indeed, during that recession, real GDP did not decline in 2 consecutive quarters but did have 2 quarters of decline during 2001. The 1990-1991 recession also never made it to 80% and again did not have 2 consecutive quarters of real GDP decline, but did have 2 quarters declining during the recession.
The message from the data seems pretty clear. The data that many people use to determine if we are in recession territory tell us that it seems unlikely. It is possible that the NBER, a few months from now, will deem that we were indeed in a recession at some point in the past, but the data today is not speaking the same language.
The BLS announced that payroll employment increased 263,000 in September with an additional 11,000 revision to July’s numbers. Employment gains were widespread with only retail (-1,100), transportation and warehousing (-7,900) and government sectors declining (-25,000). The service sector added 244,000 jobs, of which health care (75,000) and leisure and hospitality (83,000) the prime movers.
Figure 1
Figure 2
Figure 3
Employment in retail has traditionally been higher than that in the leisure and hospitality sector. After the Great Recession leisure and hospitality employment grew much faster than retail and overtook retail employment in 2018. The pandemic had a devastating effect on employment in both sectors with leisure and hospitality taking a much larger hit. Recovery was pretty swift and the two sectors are now equal in terms of employment. It remains to be seen if leisure and hospitality employment will again outpace retail employment.
Figure 4
Average hours of work remained at 34.5 and with the employment increase lead to a 0.17% increase in total hours worked. Average hourly earnings increased from $32.36 to $32.46. Year over year CPI inflation is hovering around 8% and average hourly earnings over the year have risen 5%, leading to a 3% decline in real earnings as shown in Figure 6.
Figure 5
Figure 6
Figure 7 takes a longer view of the average real wage in the US. In this figure, we have normalized average hourly earnings, the CPI, and PCE deflator, setting each equal to 100 in March 2006 — the first available date for average hourly earnings. We have used a logarithmic scale for the vertical (y) axis so that a straight line represents a constant growth rate. The average real wage is given by the difference between average hourly earnings and a price index, represented by the gap between the average hourly earnings line, and that of a price index. In fact, since we have used a logarithmic scale, a constant gap implies a constant percentage gain in the average real wage, measured since March 2006. For the most part, there is a positive gap between average hourly earnings and either the CPI or PCE deflator. This means that, relative to March 2006, the average real wage has, for the most part, increased. The exception to this pattern of real wage gains is in the midst of the Great Recession (2007-09) when the CPI line lies above that of average hourly earnings which means that real wages declined relative to March 2003.
Figure 7
Figure 8 redoes the analysis underlying Figure 7, but focusing on the COVID-19 pandemic and its aftermath. To this end, we normalize average hourly earnings and the price indices to equal 100 in February 2020. As with Figure 7, the average real wage is the difference between average hourly earnings and either the CPI or PCE deflator. Once more, real wage gains are visually represented by the gap between the average hourly earnings line and that of a price index. Measured again by the CPI, the average wage was higher than its pre-pandemic level through 2020 and 2021. However, starting in early 2022, the CPI line rises above that of average hourly earnings which means that the average real wage has fallen, again relative to February 2020. An advantage of Figure 8 over a plot of the real wage is that it gives some perspective on the source of real wage movements. In particular, since mid-2020, nominal wages have grown at roughly a constant rate (the average hourly earnings line is almost a straight line). It’s the increase in the CPI, starting in 2021, that has eventually led to a decline in real wages. However, using the Fed’s preferred measure of the price level, the PCE deflator, shows that the average real wage has increased relative to February 2020, although these gains have eroded somewhat in 2022.
Figure 8
The household survey showed a 57,000 decline in the labor force. The number of unemployed persons fell 261,000, the number employed increased 204,000, leading to a decline in the unemployment rate from 3.66% to 3.49%. Note that the labor force participation rate remains lower than it was pre-pandemic.
Figure 9
Figure 10
Initial and continued unemployment claims were released last week and there was a hefty uptick in initial claims, climbing to 219,000 and a moderate increase in continued claims, rising to 1,361,000.
Figure 11
Figure 12
Although there has been a bit of a slowdown in some parts of the economy, the labor market continues to look pretty strong. Job vacancies have declined somewhat in recent months but there are still about 2 vacancies for each unemployed person.
