Renewed labor market jitters
We had always viewed the seemingly strong January payroll number with a big dose of skepticism. The February update, which showed a surprising 92k decline in employment (versus the 55k gain expected by consensus), suggests this was wise. Although the February print was made worse by strike activity (a cleaner read might have been around -60k), it nonetheless brought to the forefront our underlying concerns around AI-related labor displacement.
The unemployment rate rose one tenth to 4.4%, where it has settled in four of the last six months. Given the magnitude of the overall decline, most sectors experienced losses. The two small exceptions were retail trade (+2k) and financial services (+10k); neither seems convincing. Wage inflation was a touch firmer than consensus forecasts but in line with others. Still, wage inflation (average hourly earnings) remains well contained at 3.8% YoY when measured for the entire worker population and at 3.7% YoY for production and non-supervisory employees. The labor market does not appear to be a source of meaningful inflationary pressures at the moment.
The tug of war between seemingly improving cyclical signals of labor demand and the structural pressure on employment stemming from AI adoption will not be resolved any time soon. It is likely that we will continue to see some positive labor market updates interspersed with weaker data in coming months. In our view, however, the AI displacement narrative is likely to intensify over time and ultimately prevail as the more important force. The result is a modest rise in the unemployment rate to about 4.7% in the fourth quarter. The rise would be even more pronounced if not for soft labor participation.
It is on the basis of the labor market vulnerability that we continue to forecast three Fed rate cuts this year despite the short-term rise in headline inflation due to higher oil prices. We assume a fairly short military engagement; should that assumption be challenged, we would likely remove one of those cuts from the forecast. At the moment, it appears premature to do so; instead, we shifted the first cut from April to June.
