Alternative Labor-Market Data Are Sending A Message Investors Should Heed (January 8, 2024)

Employment measures from the ISM and NFIB suggest the job market isn’t so solid–and Fed expectations may be too sanguine

By Lisa Beilfuss

The latest employment situation report from the Labor Department has bolstered soft-landing expectations. But investors relying on it for economic and monetary policy signals may be caught off guard. 

In the wake of the December jobs report, Treasury Secretary Janet Yellen tried to confirm what much of Wall Street has been betting. “What we're seeing now I think we can describe as a soft landing,” Yellen said on CNN Friday. But any such landing will likely be a layover.

First, a reminder about why investors should remain skeptical about jobs-report headlines and cursory analysis based on them. The figures that get the most air time, the nonfarm payrolls change and the unemployment rate, were solid at 216,000 and steady at 3.7%, respectively. But the details belie the headlines. Here are a few.

Some 676,000 people left the labor force last month, the most since January 2021, putting artificial pressure on the unemployment rate. Full-time employment fell by 1.5 million, the fourth biggest drop on record going back to 1968. Temporary hiring, one of the few leading indicators in the monthly jobs report, fell for the eleventh straight month. Ten of the past 12 nonfarm payrolls numbers have been revised lower, to the tune of 472,000–a level Piper Sandler chief economist Nancy Lazar says is typical of recessions. 

That is not to mention government hiring, which accounted for 24% of all hiring in December. It wasn’t an anomaly. Total government payrolls last month broke the record previously set in mid-2010, and government hiring represented a full quarter of overall hiring in 2023. 

There are alternative data sources to the Labor Department’s employment situation report. At least three privately compiled metrics are sending a message investors should heed.

Consider the employment component of the Institute for Supply Management’s Services PMI. It dropped 7.4 points from November to 43.3–the weakest since August 2009 and well into contraction territory (50 is expansion-contraction threshold in such diffusion indexes). 

In the history of the ISM Services employment index, which goes back to 1997, there are only three periods with a bigger plunge, says Arch Capital Group global chief economist Parker Ross. Those periods include November 2008, which marked the worst monthly job losses of the 2007-2008 financial crisis; March and April 2020, when parts of the economy were shut down; and February 2014, when severe winter weather hurt job growth. 

One month isn’t a trend. But even if you take the three-month moving average, the jobs metric in the ISM Services report fell to the lowest level since April 2010, notes Joe LaVorgna, chief economist at SMBC Nikko Securities. 

Ross makes another observation. Before Covid, private services employment within the nonfarm payrolls report and the jobs metric within the ISM Services report used to be closely linked. But since 2021, there's been effectively no correlation between the two measures, he says. 

One explanation could be the precipitous fall in businesses’ response rate to the BLS establishment survey, which produces the nonfarm payrolls number. The response rate fell to 42% from 60% pre-pandemic, suggesting that there is increased guesswork in compiling the data and arguing for added emphasis on the ISM’s measure.

The employment component of the ISM Manufacturing survey meanwhile contracted for the third straight month in December. “These two stars do not align often,” says Troy Ludtka, economist at SMBC Nikko Securities, referring to the employment gauges in both the ISM’s Services and Manufacturing reports. He adds that in 80% of past instances where both series printed below 50, private jobs fell. In 62% of instances, the economy was in recession.

The story isn’t just in ISM data. The National Federation of Independent Businesses said in its latest report that a net 16% of small-business respondents plan to create new jobs in the next three months. While the number is still positive, it fell two points from November, it has halved from its record high in August 2021, and it reflects the lowest share since 2017.

The low-and-falling BLS establishment survey response rate aside, it may be that the ISM and NFIB data are simply leading the government’s nonfarm payrolls report. Lazar says that on average, it has taken 23 months after interest-rate liftoff for the jobless rate to rise. That 23-month mark will be hit in February. Contrary to conventional wisdom, then, it isn’t taking longer than normal for Fed tightening to boost unemployment.

One upshot of emphasizing the private ISM and NFIB employment numbers over the government’s employment report: Investors who do so should have an alternative Federal Reserve policy map. Nonfarm payrolls still topping 200,000 (before revisions) and a sub-4% unemployment rate neatly fit the soft-landing narrative and square with the Fed’s estimates for three interest-rate cuts and a drift to 4.1% unemployment this year. 

But the signals from ISM and NFIB support bets that the Fed will cut much more aggressively this year. To wager otherwise is to believe the labor-market slowdown won’t continue. Lazar asks the obvious question: “But why? Because Fed funds have likely peaked?” 

That answer is too simple–just as the analysis underlying the soft-landing narrative is some combination of incomplete, premature and naive. Using inputs including corporate profits and bank lending data, Lazar’s model for cyclical (business-cycle sensitive)-employment predicts a sharp contraction in employment this year. 

As economist at recession forecaster Arturo Estrella notes, the Fed since 1989 has paused its rate-hiking campaign just before the recession would later be known to have started (the last hike was in July). The Fed always cuts rates sharply during the recession itself, Estrella says.

Estrella’s basic but salient point taken alongside alternative labor-market indicators means that bets for six rate cuts this year may wind up looking benign.