Contradictions – The Curious Conditions of the Labor Market

By Adam Thurgood on January 21, 2024

In June of last year, I wrote a piece titled “Cracks in the Labor Market” where I analyzed a variety of leading indicators of the labor market concluding that the signs pointed to recession.  Six months later, the labor market has yet to break, and the recession has yet to emerge.   Yet, despite the passage of time without an “event” the leading indicators of the labor market have worsened while the coincident data remains robust.  What gives?

First, let’s take a look at three of my favorite leading indicators of the labor market.  The NFIB Small Business index has a sub-index that tracks how hard it is to fill job openings.  Looking at chart below, it’s clear that the level of the index doesn’t really matter for predicting recessions (red bars).  What seems to matter is when the index loses momentum.  Historically, when the 3-month average sustainably breaks below the 36-month average, recession has ensued.  Over the past several months, we’ve seen a sustainable break lower, pushing up the odds of recession.

The Kansas City Fed Labor Market Conditions index is another leading indicator of the labor market I watch closely.  Similar to the NFIB indicator above, the Kansas City Fed Labor Market Conditions index has properly signaled recession when the short-term moving average (3-month) has sustainably broken below the longer-term average (24-month).  We are now nine months into the break lower, which raises the odds of recession.

Overtime hours worked is also another useful leading indicator of the labor market.  As the economy weakens, companies will cut back on overtime hours in order to reduce labor expenses.  Thus, weakness in overtime hours-worked can be an early indicator of a slowing economy.  This metric is volatile.  However, historically a sustained decline of 10% year-over-year has indicated a recession is close to or already underway.  Two months ago, we were hovering right above that critical level.  Today, we’ve bounced back after a strong December, yet are still in negative territory.  The conclusion from this index is that despite being negative, we’ve not yet hit recessionary conditions and perhaps we are starting to improve. 

Putting it all together, two of the three indicators are clearly signaling recession while the third is signaling weakness but is not at recessionary levels.  Despite the negativity from these indicators, the actual employment numbers remain strong.  Initial claims (the number of people filing unemployment claims) came in at 187k this week, its lowest level in nearly 18 months and nowhere near the levels we would expect if a recession was occurring.  The unemployment rate is up 0.3% from the bottom but is still extremely low at 3.7%.  So why are we seeing such weak leading indicators but strong current levels of employment?

The answer lies in two charts.  First, the number of job openings to unemployed people remains elevated.  Today, there are 1.4 open jobs per unemployed person.  As you can see in the chart below, this metric hit 2.0 during the wacky covid induced demand surge.  While we have seen a significant decline, the lesson learned here is that when the ratio is above 1.0, it’s tough to see significant labor market weakness.

The second major reason we’ve yet to see the labor market break is that the job openings are highly correlated to stock prices.  The JOLTS job openings index (lagged three months) and the Russell 2000 (small cap) index have moved in lock step over the past 20 plus years.  While the Russell 2000 hasn’t seen the stellar performance of the mega-cap weighted S&P 500, it just hasn’t been weak enough to force companies to cut positions and people.

As we move through 2024, keeping a close eye on both the leading indicators of the labor market and job openings will be important.  Covid created a strange set of conditions in many different indices, making economic analysis more difficult. We see about a 50% chance of recession in 2024, due to a variety of leading indicators of the economy (and we’re seeing weakness in the Fed’s Beige Book).  Yet, until we see confirming evidence from the labor market, the probability of a recessionary outcome is far from a slam dunk.