Is Labor Hoarding Masking Job Market Weakness?

Author: Chris Wood

US employment data remains key to stress-test the extent of Fed easing expectations currently priced into markets.

This is all the more the case as it has become ever clearer that the Fed will prioritise employment over inflation if forced to choose between the two.

In this respect, an interesting issue is the extent to which so-called labour hoarding, a mindset which is the consequence of the difficulty of hiring labour coming out of the pandemic, has slowed the normal adjustment in the labour market.

This should have been expected in the context of the big increase in interest rates in recent years experienced by SMEs, which employ 73% of America’s private sector employees.

The average borrowing cost for small businesses in the past 12 months has been running at 9.4%.

There continues to be evidence of such labor hoarding.

Businesses have preserved profit margins by reducing labour costs via shorter hours and resorting to part-time employment, as opposed to reducing headcount outright.

On this point, part-time employment has risen by 1.91m from 26.25m in June 2023 to 28.16m in September 2024 while full-time employment declined by 1.13m from 134.79m to 133.66m over the same period, according to the household survey employment data.

The monthly average workweek also shows a trend towards shorter shifts and more part-time work.

The average weekly hours worked for private sector employees have declined from a recent high of 35 hours in April 2021 to 34.2 hours in September, the lowest level since March 2020.

The above is of note because, historically, when the unemployment rate starts to rise, or indeed unemployment claims, both tend to rise quickly. That raises the key issue of whether this cycle is really different because of the unique circumstances of the pandemic, or whether those circumstances will simply turn out to have delayed the adjustment in the event of the labour hoarding mindset suddenly cracking.

It could well be the case that the stress on reducing labour costs, while avoiding outright unemployment,  continues because businesses are concerned about the lack of skilled labor.

Still, given everything being written about robots and AI, it may just be that the extended labour adjustment may be another consequence of the delayed impact of monetary tightening.

Could Interest Rate Cuts be Bad for Corporate Margins?

Meanwhile, American corporates’ success in preserving profit margins can be seen in the ongoing trend in recent quarters whereby top-line growth has been slowing more than bottom line.

S&P500 annualised sales rose by 5.4% YoY in the four quarters to 2Q24.

By contrast, S&P500 annualised as-reported earnings rose by 8.2% YoY in the four quarters to 2Q24.

The other important point is the role played by higher interest rates in boosting corporate profits.

The counterintuitive point here is that the nonfinancial corporate sector’s net interest payments have declined dramatically in this Fed tightening cycle, as discussed here previously (see What a “No Landing” Means for Your Portfolio, 5 June 2024).

This is a result of both the increased return paid on cash and the refinancing of corporate bonds at historically low yields.

Thus, US nonfinancial corporates’ net interest payments as a percentage of profits after tax have declined from 20.3% in 1Q22 to 8.0% in 2Q24, the lowest level since 4Q55, based on the latest national accounts data.

In absolute terms, net interest payments have declined by 50% from an annualised US$343bn in 1Q22 to US$170bn in 2Q24 and are down 55% from the peak of US$379bn reached in 2Q19.

In this respect, there is some evidence to suggest that the interest rate driver may have been a major factor in increasing US corporate profits in aggregate.

On this point, nonfinancial corporates’ annualised net interest payments have declined by US$141bn since 4Q22 while annualised profits after tax increased by US$246bn over the same period, based on the national accounts data.

If that is indeed the case, anticipated Fed interest rate cuts may not turn out as positive for US equities as many investors are hoping, though in the case of Asia and emerging market equities, Fed easing would seem to be an unmitigated positive, most particularly if combined with a weaker US dollar.

Employment is Suprisingly Strong But Risks Remain

Returning to the issue of the labour market, while the US remains the key focus of investors for entirely understandable reasons, Europe’s labour market has also shown unusual resilience relative to history in the context of the slowdown in growth experienced last year.

The Eurozone unemployment rate fell from 6.5% in June to 6.4% in both July and August, the lowest level since the data began in 2000, after having been broadly flat over the past two years.

While Eurozone real GDP growth declined from 3.5% YoY in 2022 to only 0.4% YoY in 2023 and 0.6% YoY in 2Q24.

The most plausible explanation for this resilience again seems to be labour hoarding in the context of the problem of hiring employees coming out of the pandemic.

Still, there is growing evidence that a labour market adjustment beckons in the context of the slowdown in profit growth.

On this point, the ECB and European Commission’s data shows that Eurozone nonfinancial corporations’ annualised gross profits as a percentage of gross value added peaked at 50.1% in 3Q22 and declined to 47.3% in 2Q24, the latest data available.

As for the issue of labour hoarding, interestingly, the European Commission developed in July 2023 a new survey-based “labour hoarding indicator” based on its existing business and consumer surveys.

This measures the percentage of managers expecting their firms’ output to decline but for employment to remain stable or increase.

The EU labour hoarding indicator rose from 8.1% in February 2022 to a recent high of 13.7% in October 2022, though it has since declined to 9.7% in September.

This compares with the long-term average of 9.6% since the data series began in 1999.

But Don't Forget, The Labor Market is a Lagging Indicator

Meanwhile, if the focus remains on the potential for labour market weakening in response to monetary tightening, it also needs to be remembered that the labour market is traditionally a lagging indicator.

In this respect, it is worth noting again that, in both the US and the Eurozone, data continues to show an easing of lending standards on the part of commercial banks and a flattening out of loan growth after the decline in commercial bank lending between late 2022 and early 2024.

The Fed’s loan officer survey shows that only a net 10.3% of US banks reported tightening lending standards in the July survey, down from 42% in April 2023.

Note: Weighted average of all loan categories. Source: Federal Reserve - Senior Loan Officer Opinion Survey

The ECB’s latest bank lending survey published on 15 October also shows that a net 0% of Eurozone banks tightened credit standards for loans to enterprises in 3Q24, down from 27% in 1Q23.

While a net 3% of Eurozone banks eased credit standards for mortgages in 3Q24, compared with a net 32% reporting tightening standards in 3Q22.

Note: Data up to 3Q24. Source: ECB – Bank Lending Survey

As for actual lending data, US bank loan growth declined from 12.4% YoY in early December 2022 to 1.6% YoY in March 2024 and was 2.1% YoY in the week ended 9 October.

While Eurozone bank loan growth to the private sector slowed from 7.1% YoY in September 2022 to 0.3% YoY in September 2023 and has since risen to 1.6% YoY in August.

This credit data needs to be watched closely for any signs of a real upturn in credit growth, which would cause a questioning of the current narrative about a continuing easing cycle.

Money markets are currently expecting a further 150bp of Fed rate cuts by the end of next year following a 50bp cut in September, and 145bp of cuts by the ECB by September 2025 after the ECB has already cut by 75bp since June.

Meanwhile, unlike in America, European companies will be positively geared to declining rates.

Eurozone nonfinancial corporations’ annualised net interest payments have risen from a recent low of €24.7bn or 0.35% of gross value added in 2Q22 to €102.9bn or 1.28% of gross value added in 2Q24, based on the European Commission’s sector accounts data.

Rising Rates Mean Rising Income For Baby Boomers

Finally, there continues to be lots of talk about “K-shaped recoveries”.

In the case of America, the K-shaped dynamic is best reflected in the growing share of household spending accounted for by the Baby Boomer cohort aged 65 or over.

Americans aged 65 and above accounted for a record 22% of total consumer spending in 2022, the highest share amongst various age groups and up from only 15% in 2010, according to the Labor Department’s consumer expenditure survey released in September 2023.

While the 2023 data has just been released and the 65 and over share was still 21.5%.

The baby boomers are more willing to spend because they are now earning a 5% plus return on their savings whereas for many years they got zero.