What the Labor Market Tells Us About the Business Cycle

The US economy is showing its resiliency in the face of global slowing. Certainly, this year’s three rate cuts helped buoy the financial markets, but the US consumer, supported by a robust labor market, deserves most of the credit. US employers have added to their payrolls for 109 straight months, representing the longest stretch of hiring since records were created in 1939, according to The Wall Street Journal. The job market is so good that there are currently more openings, 7 million, than there are unemployed workers, 5.5 million.

Where are the job openings? The top three categories are trade, transportation and utilities, with 1.3 million; education, with 1.3 million; and professional & business services, with 1.2 million. Why are so many jobs unfilled? Two primary factors are standing between the currently unemployed and these open positions. First is skill set: many of those on the labor market sidelines don’t possess the required skills; arguably at least half of today’s job openings require a college degree. The other factor is location: a qualified candidate in a different city has a hard time justifying a move, especially if their spouse is employed.

Middle-market companies – enterprises with between 50 and 500 employees – have fueled the most job growth over the last 12 months, creating 943,000 net new jobs. Startups and companies with fewer than 20 employees are having a more difficult time in this environment. Over the past year, small business owners created a total of 26,000 net new jobs, although they have reduced their workforces in five of the last 12 months. That’s significant given that companies with 20 employees and fewer account for one-quarter of American jobs. We believe this trend bears watching.

The labor participation rate – the share of Americans aged 25-54 who are engaged in the workforce – measures the slack in the labor market and is a useful predictor of wages and hiring. The participation rate is currently 80.3 per cent, its highest reading since 2001. A high participation rate signals a tight labor market and, with it, higher wages as more and more employers vie for fewer and fewer candidates. In June 2010 in the wake of the financial crisis participation dropped as low as 74 per cent. Since 2010, the labor participation rate has accurately predicted year-over-year wage gains. Today’s labor participation rate suggests 3.5 per cent wage growth by April 2020.

Another factor predicted by labor participation statistics is unit labor costs: the true cost of labor, which takes productivity into consideration. Like a schoolyard baseball game, employers would prefer to select the most productive workers first if there is an abundant supply of labor. As participation rises and labor markets tighten, employers are forced to become less selective, pushing productivity lower. A tighter labor market means productivity falls, employment costs rise, profit margins decline and hiring eventually slows. Unit labor costs have grown 2.6 per cent over the last 12 months, far outpacing its 12-month average. We also note that, over the previous two cycles, hiring growth peaked when unit labor costs reached 2.4 per cent. While we believe there’s still a bit more runway for hiring, we, like employers, are closely watching labor costs.