The Labor Market May Finally Be Starting to Cool

April 13, 2023

One of the trickier aspects of the Federal Reserve’s fight against inflation has been the labor market. Despite the most aggressive tightening cycle in recent history, the Fed has been largely unable to cool the red-hot labor market, where wage growth has added to inflationary pressure.

However, a recent Wall Street Journal article points out that “several crosscurrents are at work beneath the surface, and a closer look suggests the labor market is cooling quite rapidly.”

In the Journal’s analysis, the impact of the pandemic is masking the cooling trend in the labor market. The pandemic left some sectors so understaffed that employment continues to grow, despite the Fed’s efforts to slow activity. Hospitality and leisure, for example, continued to grow at an annual rate of 4.6% in the first three months of the year, largely unchanged from a year earlier. However, sectors like construction, manufacturing, and finance, which are more sensitive to the business cycle, have seen a marked slowdown. Hiring grew by just 0.7% in the three months through March, down significantly from the 4% annualized growth a year ago.

The Journal notes several other indicators that point to slowing labor demand, such as the number of job openings falling by 17%, or 2 million, in the past year, as well as recent revisions to unemployment claims that show a clear upward trend since the beginning of the year.

At the same time that demand for workers is falling, the supply is not as constrained as it was before. The workforce participation rate was at 63.3% in February 2020, just before the pandemic began, and dropped to 61.5% by the end of that year. It has since recovered to 62.6%. While lower than pre-pandemic levels, the shortfall has more to do with the aging workforce and retiring baby boomer population. The current workforce is roughly in line with projections made by the Congressional Budget Office in early 2020, prior to the pandemic. In fact, the labor participation rate for workers aged 25-54 is 83.1%, higher than in February 2020.

The shrinking demand for workers and higher supply of available labor means that workers have less leverage to push for higher wages. Wage growth has slowed in recent months, but still remains higher than levels that would be consistent with 2% inflation. This suggests that the Fed’s actions are having an impact, but it may still be a ways to go before they see thier work as done.

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