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Research Recap | Some signs of cooling in the February jobs report

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PHOEBE WHITE: Welcome to Research Recap on J.P. Morgan's Making Sense podcast channel. I'm Phoebe White, Head of U.S. inflation strategy at J.P. Morgan, And today, I'm joined by my colleague Mike Feroli, our Chief U.S. Economist, to discuss takeaways from the February U.S. employment report, as well as the path ahead for the economy and the Fed. Mike, thanks so much for joining us.


MICHAEL FEROLI: Good to be here.


PHOEBE WHITE: So Mike, a stronger than expected 275K gain in non-farm payrolls. That was versus our own forecast for 200,000, but clearly, some weaker details in the report. So what are your high-level takeaways?


MICHAEL FEROLI: Yeah. So it was probably a little more confusing than usual report, as you mentioned. Clearly, a big beat on the headline number. However, we also had downward revisions on net of 167,000 to the prior two months. So that obviously calls into question the reliability of the signal we're getting here. In addition, there were some aspects of the household survey that were a little softer. So the unemployment rate moved up 2/10 to 3.9%, which is the highest in just over two years, and also, about 5/10 of a percentage point above the cycle low. So now, you've had a decent move higher in the unemployment rate. And we also had some pretty big declines reported in the household measure of employment. We usually favor, and most people favor, the establishment survey one as the headline, but the cross check we're getting from that suggests, perhaps, a little bit of weakness there. Overall, we still think the labor market looks pretty solid here. However, maybe that 275,000 overstates to some degree the actual underlying strength there.


PHOEBE WHITE: OK. So let's just, I guess, dig into that 275,000 number. What are you seeing as sources of that demand? Is it still concentrated in government hiring and some of those services sectors, or are you seeing some slowing beneath the surface?


MICHAEL FEROLI: So as you mentioned, a lot of strength in government, 52,000. We had I think 91,000 in health care. So just over half of total employment was in those two sectors, which may still have some catch-up hiring to do from the depressed levels after the pandemic. Though, we think they're getting closer to normal. But overall, there was actually pretty good breadth across industries in terms of hiring.


PHOEBE WHITE: OK. So, you know, you look at hiring over the second half of last year, payroll growth averaged I think something around 213,000. We're averaging 265,000 in the last three months. Are you getting worried about demand re-accelerating? I know you mentioned some of the weaker details that make you feel a little bit more comfortable, that maybe we're not. But could we be leveling off at very high levels here, and how do you think about, I guess, growth going forward?


MICHAEL FEROLI: So I do think the trend here is towards slower growth in labor demand. Probably, the broadest measure of labor demand is aggregate hours worked, and those have been slowing too over the past year, just under 1%, which is, you know, kind of a soft number there. So I do think when we step back and look at both employment and the average workweek, the product of those gives us the total number of hours worked. That does appear to be slowing, but in a gradual and very controlled manner. And so far doing better than we had anticipated in terms of that slowing. You know, I think one of the big questions here going forward is not only have we surprised in terms of the numbers of jobs, again alongside this rising unemployment rate. That has occurred with a surprise in the size of the workforce, which is not only the participation rate, which held steady last month for the third straight month, but also immigration, which has come into focus a little more here. Certainly, it was a big focus in Powell's most recent congressional testimony. So I think that's another question mark over the outlook. But the overall picture still looks like one where, if the trends continue, that we'll see positive growth but slowing growth. And that's what we're looking for over the remainder of the year.


PHOEBE WHITE: So slowing growth and supply dynamics that, at least for now, remain pretty favorable. So how should we think about whether the labor market is coming into better balance, as the Fed has said they're looking for? And I guess maybe if you can touch on just wage inflation. Clearly, the step down in wage inflation so far has come along still very strong labor market. So how are you thinking about that?


MICHAEL FEROLI: Yeah. So I guess in terms of the balance, we do feel like that's occurring. So the Fed has estimated that the natural rate of unemployment is 4%. We were a 1/2 point away from there. Now, we're 1/10 of a percentage point away from there. So we do think you're probably seeing better balance between job vacancies and the number of unemployed people. Again, this morning, we saw job leavers move down, which is also a message we got from the JOLTS report earlier this week, with the move down and quits. So people are perhaps showing a little less confidence in the ability to job hop and a little more consistent with a more normal labor market. In terms of the wage inflation, we had a soft number today, 1/10 gain in average hourly earnings on the month. That was probably partly some volatility here imparted by the weather, over the past two months. Over the past year, 4.3% growth in average hourly earnings is off the peak pretty decently. Still probably a little bit above where we would want to see that settle to be comfortable with the inflation outlook. But it does seem like that's moving in, you know, a favorable direction. And I think you bring up a good question. Why is this pretty notable deceleration in earnings taking place? You know, I think in inflation, you can say, oh, it's all goods and supply chain stuff. It's harder to make that argument with respect to wages. However, I do think, perhaps, there is some link there, which is to say the big increase in headline inflation that we saw in 2022 probably really drove higher wage demands, as people wanted to maintain their real wage. And with headline inflation having come off, maybe there's a little less of a push for higher wages to match that headline inflation.


PHOEBE WHITE: So I'm curious to get your thoughts on how the Fed interprets this report. But maybe before we turn to the Fed, clearly, next week's data is going to matter, before the March 20 meeting. What are you looking for from the CPI report next week?


MICHAEL FEROLI: So on the headline, we're expecting 4/10 for the core, 3/10 which would give neither the optimist or a pessimist comfort. It would be softer if we get that, softer than what we saw in January, but not back in the 2/10 that you'd like to see in a normal environment. And then we're thinking we could probably get a pretty strong retail sales report on Thursday, but that would mostly be just making up for the weakness that we saw in January.


PHOEBE WHITE: OK. So assuming we do get a CPI report in line with what you're looking for, what do you think the messaging will be from the Fed, at the March 20 meeting?


MICHAEL FEROLI: I think it will be pretty similar to what you heard from Powell this week, which is that they are getting closer to having the confidence that they need to cut rates, but that they're not there yet. So I think given everything we've seen and heard, we're comfortable with the first cut in June.


PHOEBE WHITE: It was interesting what we heard from Powell after the January meeting. In the press conference, he indicated strong labor markets are not a bad thing, and that they could begin cutting, as long as inflation is coming down. What do you think we really need to see for them to feel comfortable dialing back on this restriction? Do you think that's really the case, that if labor markets still stay this strong, that they could be cutting?


MICHAEL FEROLI: Yeah. So he did reiterate a few times that it's not that they want to see things move in a different direction than they have over the last six months. They just want to see it take place a little longer. So I would assume that means, if on an annualized run rate basis, core PC is between 2 1/4 and 2 3/4, they might gain that confidence. I think on the labor market, you know, I think you correctly characterized Powell's comments. At the same time, I think they would have to be a little more comfortable if they saw a further rise here in unemployment. I thought on net, and I guess the market read it the same way, today's report was perhaps a smidge dovish, just given the move up in the unemployment rate, the softer than expected earnings. But I think you wouldn't have to drag the committee along so much if you start to see job growth slip to sub 150 or something like that. I think more people would get on the bus for a rate cut.


PHOEBE WHITE: OK. So let's say inflation does continue to gradually cool here, and they get some more good data, and we do get this first cut coming mid-year. How do you think about the pace beyond mid-year? Because we've heard from Fed speakers recently that maybe they could move at a more gradual pace, maybe pause after the first cut. How are you thinking about the pace of cutting beyond mid-year?


MICHAEL FEROLI: So right now, our view has been five cuts for this year, which would be once a meeting. The most recent DOTs from December show three cuts, which would be, if we start in June, every other meeting. So right now, I think that's kind of the spread, and if we don't see slowing in job growth between now and June, then I think the DOTs forecast may be a little more on track. However, I think if we start to see some real weakness in job creation, maybe more like what we're seeing in the household survey, than I think you could pretty easily get to those five cuts. While inflation may determine whether they start cutting rates, I think labor demand is going to determine how fast they cut rates.


PHOEBE WHITE: That makes sense. Clearly, a lot of uncertainty still and a lot to digest over the next couple of weeks. We look at rates markets, where we're priced right now, about 92 basis points of easing through the end of the year. We have 10-year yields at 4.09 at the time of this recording. So pretty much in the middle of this 4 to 4.30 range that we've held over the last month or so, and not too far from our mid-year target. We look for 10-year yields to fall to just 4% at mid-year, and 3.80 at year end. So Mike, let's leave it there. Thanks so much for your time today.


MICHAEL FEROLI: Thanks for having me.


PHOEBE WHITE: And thanks to our listeners for tuning in. We hope you join us next month. For more research insights, visit jpmorgan.com/research.