Data Delusion Sets A Bear Trap (January 19, 2023)

Growing expectations for a soft landing are based in part on lagging labor data. Leading indicators flash warning signs.

By Lisa Beilfuss

One of the most widely-held assumptions about the U.S. economy is increasingly dubious. The labor market is not as tight as presumed, meaning investors should dismiss the renewed soft-landing narrative and prepare for a recession in the coming months. Readers familiar with this writer’s work may recall an April 2022 piece in Barron’s arguing that the Federal Reserve couldn’t cool inflation to its 2% target without triggering a recession. The consensus since then swung to a hard landing, but many economists and investors have recently flipped as a series of robust labor-market data and decelerating inflation figures renew hopes that supply and demand are gliding into balance. A slowdown in the fourth-quarter employment cost index reported Tuesday underpin that sentiment.

The fresh optimism is so strong that even if the rare soft landing happens, it is already fully priced into the stock market, says Jurrien Timmer, director of global macro at Fidelity. That alone is reason to maintain some skepticism. More importantly, the jubilance is folly because the conventional wisdom around the labor market is based on the wrong data. (A subsequent Praxis piece will focus on the inflation picture).

The closely-watched monthly employment situation report from the Bureau of Labor Statistics is a lagging indicator, meaning nonfarm payrolls say more about what has already happened in the economy than what will happen. That is apart from a December Philadelphia Fed report suggesting the U.S. economy added a net 10,500 jobs in the second quarter of 2022–well below the reported 1 million jobs and casting doubt over how strong hiring has actually been.

Worse is the monthly job openings and labor turnover, or JOLTS, report, which has continued to show historically high levels of employee quits and employer job openings. Aside from being particularly stale–February data are released in April–there is particular danger in relying on JOLTS data because the response rate has fallen to an anemic 30%. That is about half the survey’s pre-pandemic response rate.

Responding business answers are imputed to non-responders, notes Warren Pies, founder of 3Fourteen Research, meaning that existing JOLTS data are used to fill in missing responses. The upshot, Pies says, is that healthy businesses are double-to-triple counted, effectively inflating job-opening stats. By that logic, the reported 10.5 million job openings in November may be more like 3.5 million to 5.3 million job openings, where they trended between mid-2011 and early 2015. For context, job openings as reported in the JOLTS report fell to 4.7 million in April 2020, during pandemic lockdowns, from about 7 million at the start of 2020.

Optimists point to a third indicator: initial jobless claims for unemployment insurance, which recently fell to a nine-month low despite job cuts across big tech and beyond. But investors should be wary. First, a discrepancy between layoffs and unemployment claims isn’t new. Economists at Moody’s said in a 2018 report that fewer claims were being initiated for every laid-off worker, in part because many states had implemented program changes making it harder or less attractive to apply for unemployment insurance.

Second, severance may be delaying an uptick in initial jobless claims. Consider the move by Amazon.com (AMZN) to extend full pay and benefits for 60 days to U.S. workers it laid off, followed by varying severance packages. That matters because under some state regulations, and depending how the pay is structured, separation payments can delay or reduce unemployment benefits. Severance has meanwhile become more common. A 2021 report by human-resources consultant Randstadt Risesmart found that 64% of companies are offering severance to all separated employees, up from 44% in 2019.

Not all labor-market indicators are lagging or otherwise flawed for the purpose of predicting economic turns. To the contrary, there are some forward-looking–yet overlooked–data series that are sending a clear message. Employers often cut workers’ hours before eliminating jobs, and average weekly hours fell in December to the lowest level since the pandemic lockdowns. That is as overtime hours have fallen sharply since early 2022. The number of people working part time because they can’t find full-time work is trending higher, while the number of temporary jobs have fallen sharply since peaking in July.

Yet while leading job-market indicators signal weakening conditions, many economists and strategists will continue to emphasize the splashier but lagging nonfarm payrolls, JOLTS and jobless claims indicators. That is in part because central bankers themselves focus on those indicators–meaning an economic downturn may be deeper than even some in the hard-landing camp expect as the Fed weighs stale but sunny labor data alongside slowing, but still high, inflation numbers.

It is one thing to predict an economic downturn and another to try to pin down timing. To do so, Alfonso Peccatiello, founder of the Macro Compass Newsletter, lays out four leading indicators that go beyond the job market. He says the global credit impulse, which tracks the flow of new credit issued by the private sector as a percentage of GDP, together with the Conference Board’s leading indicator index, the National Association of Homebuilders index, and the Philadelphia Fed’s new orders index, suggest a U.S. recession starts in the next four to five months. For now, investors can enjoy a rally as many continue to call the Fed’s bluff on its higher-for-longer interest-rate pledge and believe a goldilocks scenario is unfolding. But it is a bear trap, says George Goncalves, head of U.S. macro strategy at MUFG’s institutional client group.

Risk-market pricing can skew the recession-versus-soft-landing narrative in the short run, he says, adding that markets can fool all of us some of the time. But in the end, “markets can’t trick the economy out of a recession.” Investors should thus remain focused on the data–and the gap between the data that leads and the data that lags yet drives policy. Lagging labor figures will follow what the leading indicators are flashing, and eventually the Fed will respond to a deteriorating job market that will be worse than policymakers, economists and headlines suggest because they are looking backward.