How is the US labor market doing?
For years the US job market has been very strong which encouraged tighter monetary policy. Are withheld tax receipts now slowing down to serve as the canary in the coal mine?
Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
This article is entirely free to read.
TLDR Summary
As growth risks have started overshadowing inflation risks, the labor market will be key to watch to anticipate the next rate cuts. As long as it doesn’t show cracks, the Fed has little incentive to ease. Who can blame them for their hesitation? Job creation (+8 million since 2019) and wage growth (+28% since 2019 vs. 25% cumulative inflation) has been impressive for years.
Traditional performance indicators for the US labor market do not show much weakness yet. However, there may be a signal in withheld tax receipts which are reported by the Treasury in their Daily Treasury Statement. It’s still early and could be just noise, possibly a one-off related to Trump’s job cuts in the federal administration. But it could point to a weaker labor market ahead. Historically, turning points in the growth of withheld tax receipt collection have quite often coincided with major market tops and bottoms.
The importance of the labor market
As you may recall from earlier articles, I doubt that rate cuts will have a lasting positive impact on the stock market. Ceteris paribus, they will reduce deficit spending and foreign demand for US assets. However, I do respect that rate cuts have the potential to increase short-term investor sentiment. Hence, the anticipation of rate cuts might drive stock prices higher similar to how 2019 unfolded.
As I described in the article above, there were two main drivers for the 2019 monetary policy pivot. Firstly, economic growth slowed down and secondly, long inflation expectations came down. The latter seems to have been the dominant driver.
We have seen declining inflation expectations lately and the latest CPI prints were also unproblematic. This will help the Fed to justify cuts if they choose to. However, I suspect they will need to see weakness in the labor market first. The US labor market has been astonishingly robust for many years. With the unemployment rate close to all-time lows, it’s hard to argue that they are not living up to their employment mandate.
In their latest FOMC statement, the Fed reiterated that the economy is doing well and unemployment remains low. They did however acknowledge that uncertainty has increased.
Let’s look into some of the most popular labor market gauges and then into withheld tax receipts as published in the Daily Treasury Statement.
Payrolls
Total nonfarm payroll is currently growing at an annual rate of 1.2%. This is below average when benchmarked against the last 20 years. But it’s certainly not rapidly deteriorating. At 1.2% it’s also still outpacing the labor pool that the US is working with from a demographic perspective.
Unemployment rate
The unemployment rate has been rising for almost two years, which is highly unusual outside of recessions. However, at 4.2% it remains close to the lowest it has ever been.
Participation
The labor force participation for the age group 25-54 has been showing some softening lately. But it is still above prepandemic and even above pre-GFC levels.
Wages
Growth in average hourly earnings has been declining, but it’s still growing at a rate of 3.8%, higher than for most of the time since 2007.
In real terms, wages have resumed the growth rate of the 2010s.
Job openings
Job openings were unusually high during the pandemic. This seems to have normalized and stabilized lately.
Withheld tax receipts
As I mentioned in my Fiscal Flows article in 2023, I am a big fan of the Treasury’s cash accounting because it provides very detailed insights into heart of the US economy. The cyclicality and seasonality of the Treasury’s gross and net spending has become one of the most important forces for the economy and financial markets and their tax revenues serve as a timely indicator for the health of the private sector.
Withheld income taxes (i.e. those deducted from payrolls) are the most important revenue source for the Treasury. They are collecting around $3.4tn per year, which is more than half of all Treasury revenues.
The chart below plots the YoY growth of withheld tax receipts vs. the S&P 500. It’s remarkable how closely turning points in withheld income tax collection align with market tops and bottoms. The 2017 bull market ended precisely at the time when tax growth started declining and the early 2019 bottom coincided with a rebound in tax growth. The pandemic came with some distortions in the relationship. However, the market top in late 2021 happened quite close to the peak in tax growth. And the 2024 bull market also came with an acceleration of tax collection.
The latest slowdown started about a month ago. It could be just noise, possibly related to Trump’s federal job terminations. A blip that will be forgotten faster than it got noticed. However, it could also be a turning point similar to early 2018 and early 2022. It will be important to keep an eye on this.
Sincerely,
Rene
The last chart is amazing