Rapid Labor Market Recovery Pushes Policymakers To Normalize: Emkay Global

The labor markets, specifically in developed markets have seen remarkable recovery post Covid, according to Emkay Global. There is no denying that the recovery in US and developed market labor employment has certainly appeared more V-shaped than U- or L-shaped and stands in contrast to previous "jobless recoveries". A rapidly outperforming labor market amid a high inflation outlook will make it harder for DM policymakers to push back on mounting expectations for normalization. However, the debate regarding how tight the labor markets really are has split the hawks and doves within the Fed and among market researchers. This, along with wobbly global growth, introduces fresh uncertainty. Emkay Global dissects the US/DM labor market to seek answers for this.

Q1. How does the current employment recovery look from a historical perspective?

Our analysis of the past cycles shows that even after the rapid employment recovery after Covid-19, US labor market is still a bit below the trough of the severe early-1980s recession in terms of the percentage decline in employment, and below the troughs following the 1990 and 2001 recessions as well.

Q2. Are labor shortages overstating the improvement?

There has been a solid improvement in the labor market for sure, but it requires an incisive examination, given the wider-than-normal dispersion in labor market data. The re-opening pressures have created bottlenecks/shortages in most input markets, including labor. Record job openings and strong readings for hourly earnings amid elevated unemployment look unusual, as historically the relationship between openings/wages and unemployment has been fairly tight. Besides, the US labor force participation rate remains subdued, labor supply puzzle is convoluted, wage dispersion is huge, and the BLS-adjusted unemployment rate remains elevated at 7.5%, and employment remains ~5.0mn below pre-Covid levels.

Q3. How credible is the fear of US wage-inflation spiral in this cycle?

While higher wages may suggest higher demand and wage-price spiral, our assessment reveals (1) real wages have lagged productivity gains, implying slack & possible rapid disinflation once supply normalises, (2) the wage dispersion is huge, (3) the wage/price Philips curve has flattened over the past decade, and (4) firms may not necessarily/fully pass-on higher wages to final cost in this cycle.

Q4. Can the labor supply gap be filled soon?

Possibly, yes. Although labor force participation is currently subdued, we suspect that most workers who left the labor force would eventually be willing to return, if the labor market stays tight and federal benefits and savings deplete. We estimate that of the 5mn current job losses, roughly 40% (1.9mn) is owing to unemployment and the rest 60% (3.1mn) is due to the fall in labor force. Of the 3.1mn who left the labor force, about 900k possible early retirees in the 55+ age group are difficult to lure back into the market. But we suspect the remaining 1.9mn will continue to drift back amid plentiful job openings and high wages.

Q5. Can Covid-led endemic equilibrium pose near-term challenges for labor markets?

Covid has set the US back about 15 years in its steady evolution toward services consumption, but there is no sign yet of a similar shift in employment. Despite the drastic shift in spending away from services to goods, a similar line of expansion in goods-producing employment is not seen, which is still down ~3% from pre-Covid levels. In addition, the recovery in services spending and employment remains incomplete. Some endemic equilibrium may be brewing, which could have lasting/scarring impact on labor market structure. It would likely take time to reallocate former service workers into goods production. Some reallocation of US labor toward goods production or new stay-at-home services may occur in the future.

Q 6. How to reconcile Fed policy amid healthy labor conditions and above-target inflation?

Traditionally, the Fed has tightened policy rates after the composite Labor Market Conditions index reached average to above-average readings. The current reading is inclining toward this. However, we believe this time will be different from past rate hike cycles, owing to factors such as: 1) Fed's new average inflation targeting framework; 2) mis-measurement and dispersion of labor market variables; and 3) labor market slack with real wages still lagging productivity gains, implying a fall in labor share of income.

Courtesy: Emkay Global