Federal Reserve Chairman Jay Powell reiterated his warning that getting inflation under control will
require some pain. Powell is likely making these warnings based on the arcane, clunky relationship
between inflation and unemployment. The key to getting the market back into balance is a bigger
labor force, and the economy is starting to experience a larger labor force as individuals come off
the sidelines and rejoin the job market.
“PAINFUL” RISE IN UNEMPLOYMENT?
Members of the Federal Open Market Committee (FOMC) recently issued warnings that the
path to lower inflation will be painful. The crux of that view is based on the arcane, clunky
Phillips Curve, which illustrates the relationship between inflation and unemployment. Like
many concepts in global markets, the Phillips Curve went through many iterations and has
plenty of versions. Nonetheless, the FOMC believes that the basic Phillips Curve concept is
paramount for this current environment; i.e., the economy cannot get back to a long-run 2%
inflation rate unless unemployment rises. And a future rise in unemployment could be
significant and pain-provoking, especially for lower income households.
IS CURRENT INFLATION DRIVEN BY A TIGHT LABOR MARKET?
The global economy is complex, and a simplification of reality always introduces distortions, so
perhaps we should zoom out a bit. The world experienced multiple industrial revolutions, from
mechanical to electrical to digital, and some talk about a fourth industrial revolution. Wherever
the world is in its revolutionary phase, most agree that inflationary contributors change over
time. And sometimes that change can happen quickly. We believe current inflation is a result of
large fiscal stimulus during the COVID-19 shutdowns and nagging supply bottlenecks, further
aggravated by a host of potential workers who are still on the sidelines.
The latest jobs report gave some glimmer of hope. Over a third of those unemployed and
looking for work were previously not in the labor force as shown in Figure 1. As more
individuals reenter the workforce, the labor market could loosen organically, especially as
individuals currently not in the labor force move directly into a job.
PEOPLE ARE GENERALLY FULLY EMPLOYED
There are many nuances within the labor market. Some metrics reverted to pre-pandemic
levels while others are still making new records, including the share of unemployed individuals
who just reentered the workforce. Since job openings remain elevated, those who wish to work
full time are doing so as shown in Figure 2. Since last year, the number of part timers who
would prefer a full time job is steadily declining. Therefore, most of those looking for full time
work get what they want.
CAUTIONARY TALES TOLD BY HIGH TEMP HELP SERVICES
The temporary help services industry tends to be a leading indicator for aggregate employment
trends in the U.S. During emerging periods of expansion, temp help workers tend to be the first
hired because of the relatively low cost to employers for benefits and training. Likewise, during
periods of economic slowdown, temporary workers are typically the first to get the notorious
In August, the economy has the highest ratio of temporary help workers since the data series
began in the early 1990s [Figure 3]. Perhaps this could become one area of potential pain.
The inflation fight will be slow and painful, but will the pain be as acute as some suggest? We
think the decline in the Consumer Price Index (CPI) from 9% to 6% will be much easier than
the drop from 6% to sub-3%, partially because base effects will play a larger role and supply
chains are improving. And at the core, we expect to see more people come off the sidelines
and directly reenter the workforce, loosening the labor market without a significant spike in
unemployment. One risk is the high number of workers in temporary help services since these
jobs often are the first to go during times of economic uncertainty. Another risk is a Federal
Reserve (Fed) who may not have the luxury to wait and see how the front-loaded rates hikes
earlier this year will affect the real economy. For now, the Fed will be committed to additional
front-loaded rate hikes, increasing the risks of recession next year.
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