Labor Market Clobbers Expectations Even as Wage Growth Slows, While Interest Rate-Sensitive Manufacturing and Housing Continue to Struggle

Key Takeaways:

• At its January 31-February 1 meeting, the Federal Open Market Committee (FOMC) voted unanimously to raise the federal funds rate by 25 basis points to a target range of 4.5-4.75 percent, a downshift from the 50-basis point hike in December. In his remarks, Chair Powell noted that ongoing rate increases would be likely in order to slow inflationary pressures in core services ex shelter, where the committee has not yet seen the same disinflationary trends as have been documented in core goods prices.
• Nonfarm payroll employment rose by 517,000 in January, the largest monthly gain since July 2022, according to the Bureau of Labor Statistics (BLS). Job gains were broad-based across sectors. Additionally, the BLS conducted its annual revision process this month, which led to second half 2022 employment gains being stronger than previously reported. Average hourly earnings rose 0.3 percent in January and 4.4 percent over the past year. The unemployment rate ticked down to 3.4 percent, its lowest level since 1969.
• The Employment Cost Index (ECI), a measure of labor compensation, rose 1.0 percent in Q4 2022, a deceleration of two-tenths from Q3, according to the BLS. On an annualized basis, the ECI rose 4.0 percent, still elevated by recent historical standards but a marked slowdown from the 5.8 percent annualized rate in 2022 Q1.
• Nonfarm business productivity increased 3.0 percent annualized in 2022 Q4, the fastest pace in a year, according to the BLS. Unit labor costs rose 1.1 percent annualized, a slowdown from the 2.0 percent pace in Q3.
• The ISM Manufacturing Index fell 1.0 point to 47.4 in January, its fifth consecutive monthly decline and its third straight month below the expansionary threshold of 50. Leading the decline was the new orders index, which was down 2.6 points to 42.5. The not seasonally adjusted prices paid index rose 5.1 points but remained below 50 at 44.5, indicating prices are still declining but at a slower rate.
• The ISM Services Index jumped 6.0 points to 55.2 in January after briefly dipping below 50 in December. The business activity and new orders indices were each 60.4 after rising 6.9 and 15.2 points, respectively. The prices index was down 0.3 points to a still-elevated 67.8.
• Light vehicle sales jumped 19.2 percent to a seasonally adjusted annualized rate of 16.2 million in January, the highest level since May 2021, according to Autodata.
• The FHFA Purchase-Only House Price Index rose 8.1 percent compared to a year ago in November, a deceleration of 1.7 percentage points compared to October. On a seasonally adjusted basis, prices fell 0.1 percent over the month, their third decline in the past five reported months.
• Private residential construction spending declined 0.3 percent in December, the seventh consecutive monthly decline. The drop was due entirely to a 2.3 percent fall in single-family construction spending; spending on multifamily construction and improvements were up 3.2 percent and 0.7 percent, respectively.

Forecast Impact:

Employment gains exceeded both our and consensus expectations in January. This report and the annual benchmarking process depict a labor market with considerably more momentum than we had expected given signs of weakening elsewhere in the economy. Still, we note that January figures are heavily influenced by seasonal adjustments and that still-abnormal hiring and layoff patterns may be impacting the overall payroll number. While this may be responsible for the apparent bucking of the gradually decelerating net hiring trends over the past 6 months, it still appears that the labor market is on a robust footing, reducing the likelihood of a recession beginning in the first quarter. Additionally, remarkably strong job growth has come with a slowdown in wage pressures, with the ECI decelerating over the past three quarters. In terms of monetary policy, Chair Powell noted that core services ex shelter inflation would be an important indicator moving forward. We think slowing wage growth will filter through to this component, but that additional rate hikes are likely given the still elevated level of wage pressures. We continue to believe substantially lower wage growth is unlikely to occur without a rise in unemployment and a modest recession, though we acknowledge heightened uncertainty given current labor market and wage dynamics.

While weakness remains obvious in the manufacturing sector, the ISM survey showed services rebounding from a poor December reading and once again expanding at a solid clip. The economy looks to be bifurcated to begin 2023, with services performing far stronger than expected but more interest rate-sensitive sectors, such as manufacturing and housing, essentially already in recession. On balance, the overall economy looks to be stronger than we anticipated.

Still, housing data continued to come in weak with home prices declining in November and nominal single-family construction expenditures at its lowest level in two years. We believe the recent pullback in mortgage rates may support some near-term housing activity but is unlikely to be sufficient to end the general downward trend. As such, we continue to expect housing starts and home prices to decline in 2023.

Nathaniel Drake
Economic and Strategic Research Group
February 3, 2023

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