“This Time, I’m Gone for Good”: Does the Labor Market Have Long COVID?

Last Friday, Federal Reserve Chairman Jerome Powell spoke at a Bank of International Settlements conference. He said, “I do think it’s time to taper, I don’t think it’s time to raise rates.”

On the rationale for tapering, he acknowledged that inflationary supply chain pressures are likely to persist longer than expected, but said that inflation pressures are likely to abate next year (commentary earlier this year was for the end of 2021 easing of “transitory” inflation).

On the rationale for not raising rates, Powell pointed to the five million fewer workers in the labor force compared to pre-pandemic as the reason that the Fed should not be raising rates soon (Chart 1). He said, “We think we can be patient and allow the labor market to heal.”

But does the market believe him on either point?

At the same time as Powell was trying again to break down signaling theory (we describe this in detail here), market-based inflation expectations were hitting a 20-year high (Chart 2) and the bond market was pricing in a greater probability of the fed funds rate increases.

As implied by futures pricing, the probability of three rate hikes by the end of 2022 has surged to 70% (Chart 3).

To achieve this pace of rate hikes in 2022, the Fed would first need to finish tapering. This means the Fed would need to follow Governor Waller’s prescription of tapering “early and fast,” a policy path that is far more hawkish than any of Fed Chair Powell’s and the other doves’ commentary.

Powell typing rate hikes to the reentrance of the five million fewer workers employed today versus pre-pandemic, while the market is already pricing in higher rates.

So does this mean the market expects these workers to come back quickly in order to satisfy the Fed’s employment target OR does the market think this target will be abandoned, with other pressures leading the Fed to raise rates?

The former is possible, but not likely given the pace of hikes priced in.

Chart 4 shows the monthly gains in non-farm payrolls in 2021. You can see the big one million+ hires in July, followed by the much smaller gains in August and September. These smaller gains have been explained away by factors like the Delta variant weighing on service jobs, dampening people’s desire to return work, and delaying the full reopening of in-person schools.

Some of these pressures are certainly starting to abate. So, let’s assume that job gains going forward will be close to the average of the last three months of 550k (consensus for October is for 385k, after having been beaten down by repeated large downside surprises). We can see in Chart 5 that at this rate, it would take well into 2023 to return to the pre-COVID trend of nonfarm payrolls (earlier to reach the January 2020 level).

And note this is not for lack of jobs available. Job openings are at a record high (Chart 6), while businesses continue to report challenges filling jobs (Chart 7).

But can we assume that people will return to the labor market at this 550k pace? Or that the full five million people who remain out of the labor force today will ever return?

This is where the labor market is showing signs of “long COVID.”

Based on the impact of the prior pandemic, there is precedent to expect that the COVID experience over the last 20 months will have long-run impacts on our labor force.

First, we know that the pandemic has sparked accelerated retirements in the U.S., with estimates of two million more workers compared to the normal trend having retired since the pandemic began. Roaring markets have boosted the value of retirement investment accounts, putting retirement within reach for many, with an added nudge from higher savings built lockdown/stimulus and likely some health/safety concerns.

We can see this impact by looking at labor force participation rates by age cohort. The younger 25-54 age cohort has seen a more robust recovery in labor force participation, while the 55+ cohort remains depressed (Chart 8).

Second, there is a similar story to tell my gender. Both women’s and men’s labor force participation rates are below pre-pandemic levels, but men’s participation rate is closer to pre-pandemic levels than women’s (Men is 1.6% lower than pre-pandemic, Women is 1.9% lower than pre-pandemic, representing thousands of workers difference). Some, like Nicholas Christakis, argue that women, who tend to assume the responsibility of caregivers, will lose decades of labor force participation rate growth.

Third, we know there are some amount of workers who have started their own business and are unlikely to return to “traditional” employment. They are counted in the employment numbers, have the ability to hire others as well, but are not available to work jobs that they might have previously held. This helps to explain the elevated level of job openings and quits.

So when we put this all together, we can see that the five million workers available to return to the labor force could be far lower in reality. This would indicate that the labor market is tighter than the Fed is currently acknowledging. This could spell for continued wage gains which would feed into continued elevated inflation readings and higher inflation expectations.

Of course, there is a layer of it being too soon to make confident projections about how quickly people will return to the labor force. The supplemental unemployment benefits only ended in September, which had some impact on keeping people out of the labor, while school reopening delays and COVID fears are still present.

We also know that employers are having to raise wages to find the workers they need, as shown by Chart 9 with the NFIB Small Business Compensation Plans Index at a record high. As wages continue to be pushed higher, partially thanks to competition with other employers, it is likely that some workers will be drawn back into the labor force.

But even with these, it appears that there will be growing pressure on the Fed to change its messaging around labor, acknowledging the tight labor market in some areas and the structural changes in the labor market that have resulted due to COVID. This, along with continued elevated inflation readings, could mean stepped-up hawkish commentary out of the Fed, which could likely pressure equity P/E multiples further and spur greater equity volatility (as we discuss in detail here).

 

 

 

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Cameron Dawson
CFA®, Chief Market Strategist