Hot US Labor Market, Inverted Yield Curve

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Hot US Labor Market, Inverted Yield Curve

Two items for our “Data” section today.

Topic #1: Friday’s US Employment Situation report was a case study in hot labor markets. Three points on that theme:

First, March’s unemployment rate of 3.6 percent is among the lowest readings in the last 60 years. The chart below shows US unemployment from 1960 to the present. As noted, we’ve had many economic cycles during that 6-decade span where joblessness bottomed at rates well above current levels. Neither expansion in the 1970s got close to even 4 percent unemployment, and neither did the long period of growth in the 1980s. The first 2 cycles of the new century saw unemployment trough at/near 4 percent. Only the last expansion and the Vietnam era, with its shortage of male civilian labor, printed unemployment rates as low as we had last month.

Second, total labor force participation (LFP) is finally increasing at a steady clip and prime-aged (25 – 54) LFP is getting back to pre-pandemic levels in a hurry. LFP is the percent of adults who are either employed or looking for work and has been cyclical since the early 2000s. It usually takes many years after a recession to see LFP begin to rebound. Thanks to a hot labor market, however, the bounce back is happening sooner than usual. As noted in the chart below, total LFP is starting to accelerate and working-aged LFP has returned to 2019 levels.

Lastly, and unsurprisingly given the 2 prior points, wages continue to increase at a very quick pace. The chart below shows hourly wage gains for production and nonsupervisory workers, the longest running dataset for this measure of US labor market conditions, from 1965 to the present. March 2022 showed 6.7% annual wage growth for this cohort. The last time wage growth was so high was in the 1970s/early 1980s, with no period since getting much above 4 percent.

Takeaway: even as US labor force participation increases, that incremental supply of labor is still insufficient to satisfy demand and wage pressures remain.

Topic #2: The US Treasury yield curve is now inverted, with 2-years at 2.46 percent but 10s at 2.39 pct, thanks to the market’s ever-more hawkish view on future monetary policy:

  • The week began with 10 years at 2.48 percent and 2s at 2.34 pct (a normally sloped yield curve).
  • On Friday, 10-year yields were down 9 basis points but 2-year yields were up 12 basis points.
  • While the move in 10-year yields is hardly remarkable (they’ve been in a band for almost 2 weeks), 2-year yields did hit a new high on Friday and are 16 basis points higher than a week ago.

This move in 2-year Treasury yields is due to the market rethinking Fed rate policy in the second half of 2022, rather than what may happen over just the next 2 FOMC meetings. Here is how the probabilities implied by Fed Fund Futures prices have changed in the last week:

  • May meeting: the odds of a 50 basis point rate increase are still high (69 percent) but have come down slightly in the last week from 73 percent on March 25th. The odds of a 25 bp increase rose from 27 percent to 31 pct over the same timeframe.
  • June meeting: odds of another 50 bp increase remain better than 50:50 (59 percent), but down from 62 percent last week. The second most likely outcome – a 25 bp increase – saw its odds rise by 1 percentage point. This contract does put some real odds on a 75 basis point increase (17 pct a week ago, 19 pct now).
  • December meeting: this contract puts the highest odds on Fed Funds at 2.50 – 2.75 percent by year end, and these have been stable over the last week at 39 percent. The odds that rates are 2.75 – 3.00 percent (i.e., higher than the modal estimate) are up over the last week, however, from 18 percent to 25 percent. Odds of rates being slightly lower than the mode (2.25 – 2.50 pct) fell last week from 31 percent to 24 percent.

Takeaway: 50 basis point FOMC meetings may not end in Q2. As it stands right now, there are 50 percent odds baked into Fed Funds Futures that there will be a 50 basis point increase at some point between the July and December meetings.


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