Cracks Beneath The Surface
Labor Markets, Inflation, and the Path Forward
Hi folks! My apologies for such a long gap between posts. I am going to give you a bit longer of a report today in return. I’m hoping to try to work out a more regular schedule and cadence to these posts over the holidays. I’ll be sure to let you all know!
Executive Summary
The story of 2024 was one of resilience in the face of unprecedented monetary tightening. As we enter 2025, the U.S. economy presents a complex picture of resilience masking underlying vulnerabilities:
Labor Market: Job openings have fallen over 35% from their peak while long-term unemployment is hitting a three-year high
Inflation: Proving to be stickier than expected, particularly Services Inflation, which is keeping broad based measures well above the Fed’s 2% target
Consumer Debt: Consumer credit is being supported by higher wages for the time being but increasing debt burdens could become an issue
Productivity: Notable divergence between business sector gains and manufacturing sector lag
Risk Factors: Watch for labor market deterioration, persistent services inflation, and lagged effects of monetary tightening
Let’s dive in.
The Labor Market: Warning Signals Amid Resilience
The post-pandemic labor market narrative requires careful nuance. While headline numbers remain historically strong, beneath the surface, several concerning trends are emerging that warrant close attention.
Job Openings: A Clear Downward Trend
Perhaps one of the most telling indicators of labor market softening is the steady decline in job openings. After peaking at 12.18 million in early 2022, openings have fallen sharply to around 7.74 million – levels last seen in the early stages of the post-COVID recovery.
The pace of decline suggests a structural shift in hiring intentions rather than a temporary pause. We're now seeing openings approach levels that preceded the pre-pandemic "normal" period. As of now, the trend shows no signs of stabilizing, with recent months continuing to show deterioration.
Duration of Unemployment: A Growing Concern
One of the most telling indicators is the number of Americans unemployed for 27 weeks or longer, which has now reached a three-year high.
These aren't yet crisis levels, but they suggest the job market's underlying dynamics are weakening more than headline unemployment rates might indicate.
Initial Claims & Continued Claims: Momentum Shift
The trend in initial jobless claims has taken a decisive turn the last few weeks. Unlike a couple months ago, this cannot be blamed on any Hurricane related issues. What’s more is Continued Claims has continued to move higher for the past 2 years. While both measures are low historically, the recent trends signal to us a labor market that is weaker than it may seem at first glance.
Small Business Stress: A Leading Indicator
Perhaps most concerning is the deterioration in small business conditions.
Poor sales reports from small businesses have historically been a reliable predictor of rising unemployment. Given that small businesses account for a significant portion of U.S. employment, this weakness could foreshadow broader labor market stress.
Employment Structure: Signs of Adjustment
Full-time employment has plateaued, but the context is crucial. Rather than maintaining strength, this plateau might represent a hesitation among employers to maintain current staffing levels. The subtle shift toward part-time employment could be interpreted not just as flexibility, but as a defensive posture from businesses anticipating tougher conditions ahead.
While still below the post-Covid or post-Financial Crisis levels, the lengthening unemployment duration is worrisome. After bottoming 2 years ago, it has been rising and doing so even more rapidly of late. This suggests that finding replacement employment is becoming more challenging for displaced workers.
The Great Wage Reset
Perhaps the most fascinating aspect of the current labor market is the evolution of wage dynamics. The "Great Resignation" that dominated headlines in 2021-2022 has transformed into what we might call the "Great Hesitation" as people have become more hesitant to leave their jobs.
The Quit Rate, once a barometer of worker confidence, has descended from its peaks. This hasn't triggered a collapse in wage growth yet, however wage growth tends to lag the Quits Rates by about a year. Looking ahead wage gains will likely be muted. We're seeing a gradual moderation that suggests a shifting balance between worker and employer leverage. This is crucial for the inflation story.
Inflation: The Long Goodbye
The inflation narrative has evolved from "transitory" to "sticky" to what we might now call "gradually retreating." But this retreat isn't uniform across the economy.
Services inflation remains persistently elevated, even as goods prices have normalized. This divergence tells us something important about the nature of this inflation cycle. The initial supply chain disruptions that drove goods inflation have largely resolved, but the second-order effects – particularly in services – have proven more durable.
The trimmed mean PCE inflation rate offers a cleaner look at the underlying trend, stripping out the most volatile components. Its gradual descent suggests we're on the right path, but the journey to 2% will be measured in quarters, not months.
The Consumer Paradox
One of the most intriguing aspects of the current environment is the state of the American consumer. On one hand, we see early warning signs in credit markets:
Delinquency rates are way up from the historical lows, suggesting that some households are feeling the strain of higher rates and persistent inflation. However, this needs to be viewed in context.
Mortgage debt service ratios remain surprisingly manageable, thanks in large part to the refinancing wave of 2020-2021 that locked in historically low rates. Despite recent concerns about housing affordability, households are generally dedicating a smaller portion of their income to mortgage payments than they did in the 1980s and significantly less than during the 2008 housing crisis.
While the recent uptick bears watching, we're still far from the dangerous levels seen during the housing bubble. This suggests that, on average, homeowners are in a better position to manage their mortgage obligations than in previous high-stress periods. This provides a crucial buffer against housing market stress.
The Productivity Disparity
Perhaps the most underappreciated story of the past few years has been the divergence in productivity across sectors:
Business sector productivity has accelerated, helping to square the circle between wage growth and inflation. This represents real investments in technology and efficiency that could help sustain growth even as the labor market cools. Manufacturing sector productivity, on the other hand, is weakening which could weigh on growth particularly if labor markets for the sector deteriorate as well.
Looking Ahead: The Path to Equilibrium
As we look to 2025, the data points to an economy finding its footing at a new equilibrium. The labor market is cooling without cracking, inflation is moderating without collapsing, and productivity gains are providing a cushion against margin pressure.
This doesn't mean we're out of the woods. Several key risks bear watching:
Further deterioration in the Labor Market as people continue to have difficulty finding a job and more people begin losing the ones they did have.
Services inflation could prove more persistent than expected, particularly if wage growth remains elevated
The lagged effects of monetary tightening might still filter through to the real economy
Consumer resilience could fade as excess savings are depleted and credit stress builds
That’s all for now folks. Thank you for reading! Please share with anyone else who may be interested in our work. Until next time…