Fed Holds Rates Steady as Labor Market Cools but Remains at Healthy Level

Key Takeaways:

• The Federal Open Market Committee (FOMC) held the federal funds rate at its current target range of 5.25-5.5 percent at its October 31-November 1 meeting, while stating that future tightening decisions will continue to be data dependent. The committee is continuing to reduce its Treasury and MBS holdings and, according to Chair Powell’s press conference, is not considering changes at this time.
• Nonfarm payroll employment increased by 150,000 in October, according to the Bureau of Labor Statistics (BLS). While a slowdown compared to September, the United Auto Workers strike contributed to a loss of 33,000 jobs in auto manufacturing, which will likely reverse next month. August and September job gains were revised downward by a combined 101,000. The unemployment rate ticked up one-tenth to 3.9 percent, half a point higher than its recent low in April. Wage growth cooled, rising 0.2 percent over the month and 4.1 percent compared to a year ago.
• Nonfarm business productivity increased at a 4.7 percent annualized rate in Q3 2023, the fastest rate since 2020, according to the BLS. Given the comparatively strong gain in productivity, unit labor costs declined at an annualized rate of 0.8 percent. Compared to a year ago, productivity was up 2.2 percent.
• The Employment Costs Index (ECI), a measure of labor compensation, increased 1.1 percent in Q3 2023, a slight acceleration of one-tenth compared to the second quarter, according to the BLS.
• The Job Openings and Labor Turnover Survey (JOLTS) showed job openings increased by 56,000 to 9.6 million in September, though the previous month’s gain was revised downward by more than 100,000 openings, according to the BLS. The quits rate was flat at 2.3 percent for the third consecutive month, which is the same level it was at before the pandemic.
• The ISM Manufacturing Index dropped 2.3 points to 46.7 in October after three months of increases to reach its lowest level since July. The new orders index declined 3.7 points to 45.5 and the production index was down 2.1 points to 50.4. Supply chain and price pressures continued to ease with both the supplier deliveries and non-seasonally adjusted prices paid indices remaining below the expansionary threshold of 50.
• The Conference Board Consumer Confidence Index declined 1.7 points to 102.6 in October, its lowest level since May. Consumer confidence in the present situation declined 3.1 points to 143.1, while expectations for the future were down 0.8 points to 75.6.
• Light vehicle sales declined 0.6 percent to a seasonally adjusted annualized rate of 15.6 million in October, according to Autodata.
• Private residential construction spending rose 0.6 percent in September, according to the Census Bureau. Single-family construction spending rose 1.3 percent, its fifth consecutive monthly gain, while expenditures on multifamily construction declined 0.1 percent. Spending on improvements rose 0.2 percent.
• The FHFA Purchase-Only House Price Index rose a seasonally adjusted 0.6 percent in August. Compared to a year ago, home prices increased a non-seasonally adjusted 5.6 percent, an acceleration of a full percentage point from the prior month.

Forecast Impact:

Employment gains were in line with our expectations. The labor market has clearly cooled from its strength earlier in the year but remains in a healthy state. With average hourly earnings up just 2.5 percent on an annualized basis and the unemployment rate edging up towards estimates of the natural rate of unemployment, this report is consistent with inflation trending toward a 2-percent inflation target, especially given recent productivity growth.

While the surge in productivity through the second and third quarters of this year is unlikely to be sustained at this rate moving forward, unit labor costs outright declined and, compared to a year ago, were below a typical pre-pandemic growth rate at just 1.9 percent. Combined with some temporary boosts from improving supply-side factors, this helps to explain in part the combination of rapid economic growth and declining inflation over the past several quarters. Still, the ECI, which is a more comprehensive measure of wage growth, remained at a level that is likely a bit too high to be consistent with 2-percent inflation in the long run if productivity growth returns to a more typical level, suggesting some additional loosening in labor market conditions may still be necessary to sustainably return to target inflation. As such, we expect the Fed will keep policy tight until it is clear that labor market conditions are consistent with their inflation target.

The decline in the ISM Manufacturing index gave back most of its improvement over the past three months and returned the overall level to at or near recessionary levels. While this may improve with the likely conclusion of the United Auto Worker strikes, poor consumer confidence and ongoing weakness in new auto sales suggest consumer demand may be softening. This would be in line with our forecast for significantly softer economic growth in the fourth quarter.

Nathaniel Drake
Economic and Strategic Research Group
November 3, 2023

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