Vice-President, Chief Economist and Strategist
It seems like ages since COVID infections were the most influential variable shaping the economic outlook. Monetary policy is now in the driver’s seat, and central bankers are acknowledging that it will be difficult to bring down inflation if wage pressures remain this elevated. But in the US, the August jobs report offered some encouraging signs, with the labour force growing by a net 786,000 workers during the month. The Beige Book for August released this week similarly noted some improvement in labour availability and retention.
What hasn’t changed is that the job market remains—to use a housing expression—a seller’s market. Corporations are now making full-time offers to college students well before they graduate, and those offers tend to be more generous than in the past. Signing bonuses and more flexible hours have almost become the norm. Our business contacts have been telling us candidates are increasingly picky on remote working arrangements. Requiring them to show up in a downtown office just a few days a week can now be a dealbreaker. Even the Bank of Canada seems to be adapting to the times, allowing its next Deputy Governor to work not just remotely, but part-time as well.
But the Governor still works full-time, and he’s trying to figure out how to stop the madness. He did try moral suasion this summer, essentially asking small business owners to hold the line and resist the temptation to build current inflation into future compensation contracts. This advice didn’t sit well with unions, not least because average wage growth still isn’t keeping up with inflation.
But Macklem may have been on to something—that labour scarcity is leading to acute mispricing, heightening the risk of correction. Such a scenario could be triggered by expectations for housing to correct and consumer spending to weaken in the quarters ahead, dampening GDP growth and business profitability. Typically when this happens, businesses pull job postings and cut hours, hoping for a soft patch.
But as a recovery remains elusive, inventory builds and cash flows dry up, layoffs tend to follow soon thereafter. We aren’t there yet, although August saw the first increase in permanent job losers in the US since February 2021, and there have been some noteworthy downsizings in the tech, automotive, finance and retail sectors lately. For now, the hard evidence on layoffs remains mixed overall. But given the signs of cracks, we’ll have to keep a close eye on the upcoming data. This is also true in Canada, where a surprise 0.5 percentage point rebound in the unemployment rate was recorded in August. Outside of pandemic lockdowns, such a strong increase has typically coincided with a recession in Canada.
As the debate around the future path of the Beveridge curve rages on, Fed officials have taken the view that moderating demand could reduce job vacancies while preventing an increase in unemployment. This scenario is not inconceivable, but history shows it tends to be rare. Currently, the US job openings rate is 0.4 percentage points below its March 2022 peak, and since 1951, every time it has fallen more than 0.5 percentage points from its peak, a spike in the unemployment rate (and therefore a recession) has followed (graph on page 2).
The key will be how quickly the economy weakens. If demand plummets, businesses struggling financially won’t improve their prospects by just removing job postings. In the case of a more gradual slowdown, however, we could see companies on a better footing take advantage of the situation to hire workers laid off by more fragile businesses. This would limit the impact on unemployment. What remains true, however, is that the more businesses base worker pay on labour scarcity rather than value added, the more likely they are to face financial trouble when demand starts to wane.
Businesses that think turbocharged demand and strong pricing power are here to stay are in for a rude awakening when central banks eventually break those dynamics. In our view, the businesses that will struggle the most a) are still saddled with pandemic debt, b) are vulnerable to cutbacks in consumer discretionary spending, c) would be hurt by the housing correction, d) have seen significant increases in labour costs, or e) all of the above. Macklem’s recommendation may have drawn the ire of unions. But it wasn’t necessarily bad advice.
Read the full commentary: Is the Labour Market at a Crossroads?