US employment numbers suggest the Fed's tightening cycle may be over

By Stuart Cole | @Stuart Cole | 3 November 2023


A heavier moderation than expected in today’s US employment figures, an outcome that has very much reinforced the message given by Powell at this week’s FOMC meeting, i.e. that signs of a softening in the labour market are growing, removing one of the big obstacles to the Fed officially ending the current tightening cycle. Coming on the back of September’s strong report – largely regarded as something of an outlier – the softer print today continues the pattern seen this year of big increases in the payrolls numbers being followed by much smaller gains over the next couple of months. And if the pattern of downwards revisions that we have seen each month this year is continued – the August and September payrolls numbers were today revised downwards by 101k - then the implication is that today’s 150k reading will similarly be revised lower too. Taking all of this into consideration, it is hard not to conclude that downside risks to the labour market are growing, and as the lagged impact of the Fed’s tightening increasingly drags on economic activity, so these downside risks are going to grow.

The reported increase in the unemployment rate from 3.8% to 3.9% is mainly explained by the rapid expansion being seen in the size of the US labour force, largely the result of growing immigration. But the key issue this presents is the potential for the rate of unemployment to reach 4.0%. This will mean the level of unemployment will be more than 0.5% above this year’s low, potentially triggering the Sahm Rule. The Sahm Rule states that when the three-month moving average of the unemployment rate rises by 0.5% or more relative to its low during the previous 12 months, then the US economy is in recession. At 3.9%, the unemployment rate is currently 0.43% above its 12-mth low. The caveat to the Rule this time around is that the increase in the unemployment rate is being driven by an expanding labour force as opposed to a falling level of employment per se. But the mere suggestion that the Sahm Rule is starting to apply will hugely increase the pressure on the Fed not to raise interest rates any further.

In addition to the softer employment figures, the wages growth numbers are similarly showing signs of slowing. Today's report showed that between July and October the annualised 3-mth rate of increase was 3.2%, the smallest rate of growth since end-Q1 2021 and putting wages growth back in line with pre-pandemic levels. Wages growing at this rate will be viewed by the Fed as in line with a CPI target of 2%, given expected productivity gains, and should put to bed any lingering fears the Fed has regarding the risk of a wage/price spiral. However, it will want to see the average hourly earnings figure finally moving below the 4% level before it will consider this threat to be fully eliminated

Employment is typically the last shoe to drop when an economy is facing a downturn, and with the various measures of inflation already suggesting pricing pressures are easing, today’s numbers have allowed the bond market to start pricing in more cuts during 2024: some 85bps of loosening is now seen as being delivered next year, considerably more than the 50bps pencilled in by the Fed in September’s dot plot.

Overall, today’s numbers provide the Fed with the further ammunition it needs to keep interest rates on hold in December and allow it to bring to an end the most aggressive tightening campaign that has been seen since the early 1980s.