Labor Day: The job market is cooling the right way

For eighteen months economic orthodoxy held that bringing inflation down would require a painful jump in unemployment. Economists warned that the Beveridge curve would steepen and push millions out of work before wage pressure eased. The August jobs data suggest the American labour market may be managing something rare, cooling vacancies while leaving employment intact.

How the pessimists built their case

The gloomy view had respectable authors. In 2022 Olivier Blanchard, Alex Domash and Lawrence Summers argued that the link between vacancies and unemployment had shifted so far that disinflation would need a substantial rise in joblessness. Christopher Waller and Andrew Figura of the Federal Reserve replied that at very high vacancy rates the curve is steep, so openings could fall sharply with little increase in unemployment. The Fed then lifted its policy rate from near zero to between 5.25 and 5.50 per cent, turning an academic dispute into a live experiment.

Vacancies fall, payrolls hold

The unemployment rate rose to 3.8 per cent, but mostly because more people joined the labour force. Widespread layoffs have not arrived. Job openings, meanwhile, have fallen by millions from their post-pandemic peaks. If companies can cancel unfilled positions without cutting existing staff, the Fed may get its 'soft landing' without widespread hardship.

The detail supports that reading. Employers added 187,000 jobs in August, and the participation rate climbed to 62.8 per cent, its highest since before the pandemic. Openings fell below 9 million in July for the first time since early 2021, down from about 12 million at their peak in March 2022. Quits have dropped as well, which matters because workers who switch jobs capture the largest pay rises. Fewer vacancies and fewer quits mean less wage pressure without anyone being fired.

Pay data point the same way. Average hourly earnings rose 0.2 per cent in August, the smallest monthly gain in well over a year, and 4.3 per cent from a year earlier. That annual pace is still above what two per cent inflation allows, which is roughly the target plus the trend growth of productivity, but it has been falling steadily from peaks above five per cent last year. Wage growth that slows while employment keeps rising is the combination the Fed has been hoping for.

Supply did some of the work

Part of the improvement has come from more workers rather than fewer jobs. Participation among people aged 25 to 54, the group least affected by retirement and schooling, has climbed to its highest in about two decades. Immigration, which slumped during the pandemic, has recovered, adding to the pool of workers in hospitality, construction and care. More applicants for each opening let employers fill posts without bidding up wages, which cools pay growth without anyone losing a job.

That matters for how the Fed reads the rise in unemployment. A jobless rate that climbs because new entrants take time to find work is a sign of a healthy market drawing people in, not of one pushing them out. The August report showed exactly that pattern: the labour force grew by far more than employment, so the rate rose even as hiring continued.

Why this cycle may differ

Soft landings are rare but not unknown. Between early 1994 and early 1995 Alan Greenspan's Fed doubled its policy rate from 3 per cent to 6 per cent, and the economy slowed without tipping into recession. The present cycle has an unusual cushion. After the pandemic, companies kept job advertisements open as insurance against labour shortages, so much of the adjustment can come from withdrawing posts that were never filled. Deleting a vacancy costs an employer nothing, whereas letting a trained worker go costs severance and skills that are hard to rebuy.

That asymmetry explains why the ratio of openings to unemployed workers has fallen from about two at the peak to roughly one and a half without a matching jump in joblessness. Employers that struggled to hire in 2021 and 2022 are reluctant to shed staff they may need again. For the Fed, the combination is close to ideal: slack returns through the vacancy count rather than the dole queue.

Weak spots in the data

The optimistic reading has cracks. Payroll gains for June and July were revised down, and the pace of hiring has slowed markedly over the summer. Temporary-help employment, often an early casualty of a downturn, has been shrinking for more than a year. Borrowers also face the resumption of student-loan repayments in October, which will squeeze spending just as households run down the savings they built up during the pandemic.

History also counsels caution. Unemployment tends to rise slowly at first and then quickly, because job losses cut spending, which prompts further job losses. In 2000 and again in 2007 the jobless rate drifted up by a few tenths of a point before accelerating, and in both cases the early drift looked benign at the time. The Beveridge curve can be steep near the top and flat near the bottom: once vacancies return to normal levels, further cooling has to come through redundancies rather than cancelled adverts.

Sector-specific shocks add noise. The collapse of the trucking firm Yellow in August took tens of thousands of jobs with it, and strikes by Hollywood writers and actors have idled production. The United Auto Workers' contracts with Detroit's three carmakers expire on 14 September, and a strike there would depress payrolls in the autumn for reasons unrelated to the Fed.

None of that has yet shown up in the jobless rate. Economists track the Sahm rule, which flags a recession when the three-month average unemployment rate rises half a percentage point above its low of the previous twelve months, and the current rise falls well short of that threshold. The next tests are the Fed's meeting later this month, where markets expect rates to be held, and the September payroll and job-openings figures, which will show whether employers are still trimming advertisements or have moved on to trimming staff.

The labour market is cooling in an orderly way, with vacancies disappearing faster than jobs. If that holds through the autumn, central bankers may bring inflation down with few redundancies to show for it, and the Fed is likely to hold rates this month rather than risk turning a gentle slowdown into the jump in unemployment the pessimists predicted.