Transcription
Every month, the highly anticipated jobs report is released, and within seconds, financial media declares victory or disaster based on one number. Did payrolls beat or miss expectations? That's completely useless.
Buried inside that same report is a metric that's predicted every recession months and sometimes years in advance. It flagged March 2000 before the dotcom crash, July 2006 before the housing collapse, and again in March 2023. In this video, we'll look at exactly what this metric is, how to track it, and what it's telling us right now about where the labor market and the economy is actually heading.
Here's what most people get wrong about the economy. They think it all moves at once, like one day everything is fine and the next day there's a recession. That's not how it works. The economy moves in a sequence. Certain sectors are more sensitive to interest rates and credit conditions, which means they have to react first when monetary policy changes.
What are these main sectors? It's construction and manufacturing. These two industries are responsible for the vast majority of job losses in every recession. Not technology, not retail, not hospitality, construction, and manufacturing. So, if you want to know where the labor market is actually heading, you don't watch total non-farm payrolls. You watch these cyclical sectors first because that's where the cracks always appear.
You can divide private payrolls into two buckets: construction and manufacturing, and everything else. You can call this cyclical versus non-cyclical payrolls. Right now, the narrative is that the labor market is weakening. But when you split it like this, you can see that the weakness is not showing up at all in the non-cyclical sectors. It's concentrated in construction and manufacturing, exactly where you'd expect the weakness to appear after a monetary policy tightening cycle.
But we can go even deeper. Within construction, there's residential construction and non-residential construction. Within manufacturing, there's durable goods and non-durable goods. Residential construction is more cyclical than non-residential construction. And durable goods are more cyclical than non-durable goods. So the most leading signal comes from combining the most sensitive categories: residential construction and durable goods manufacturing.
This chart is the key to everything. It shows the growth rate of the labor market broken down by sectors. The blue line is residential construction payrolls plus durable goods manufacturing payrolls. The orange line is total construction and total manufacturing, slightly broader. The purple line is total non-farm payrolls, the number that everyone focuses on. Look closely at what happens before each recession. The blue line breaks down first, then the orange line follows, and then finally the purple line catches up, but by then the economy is already in or about to be in recession. If you watch total non-farm payrolls, you're looking in the rear view mirror. You're years behind the actual inflection points.
Now, this is where it gets more interesting and more important for asset markets and investing implications. In this chart, there are four dates where the blue line, the most cyclical sectors, broke away from total non-farm payrolls in a meaningful way: March 2000, July 2006, July 2019, and March 2023. And look at what happened after each of those signals occurred. Every single one preceded a significant change in monetary policy.
Now, this isn't a precise timing tool. We should be clear about that. Nothing in business cycle analysis is about predicting tops and bottoms or exact trading signals. But the sequential deterioration in leading labor market categories is one of the most reliable signals we have for where the Fed is eventually heading with monetary policy. That signal triggered again in March 2023. Now, the Fed did continue to raise interest rates after that, perhaps cushioned by some of the bank bailouts, but here we are now with the Fed still in a rate cutting cycle.
The labor market sectoral breakdown that we just reviewed comes from something called the establishment survey. The monthly employment report has two surveys: the establishment survey and the household survey. The establishment survey, which is where the data we just looked at comes from, is great for granularity, but it does get revised very heavily. The household survey is the opposite. There's less detail about sectors and industries, but revisions are minimal, which makes the unemployment rate, which comes from the household survey, the gold standard for assessing where the labor market is right now.
Currently, the unemployment rate is about 4.4%. That's a cycle high, and the trend is clearly worsening. The level itself, 4.4%, isn't alarming. But here's what matters. When you combine both surveys, you get a three-dimensional view of the labor market. The unemployment rate is rising. It's at a cycle high. And we see that the weakness is coming from exactly where we'd expect it to come from after a monetary tightening cycle: the cyclical sectors of construction and manufacturing. This isn't random softness. It's a sequential deterioration following the same pattern we've seen before every business cycle slowdown.
There's one more layer that we should look at in each monthly jobs report, which comes from the household survey. What we call labor intensity. When companies need a lot of work done, they hire full-time employees. When demand softens, they cut hours before they cut bodies. At the peak of the pandemic boom in 2021, full-time employment hit almost 81% of the labor force, the highest level ever recorded. That's now dropped below 79%. And if we look at part-time employment for economic reasons, meaning people who want full-time jobs but can't find them and thus settle for part-time jobs, we can see that at the peak in 2021, less than 2.5% of workers were part-time for economic reasons. That's climbed to about 3%. It's not a dramatic spike, but directionally it is weaker. So, we can see that companies are throttling labor intensity before making the harder decision to actually cut jobs aggressively.
So, what does all of this tell us about where the economy is heading? The Federal Reserve's own projections show that most committee members don't expect unemployment to rise above 4.5% in 2025, 2026, or 2027. Based on everything that we just walked through: the sequential breakdown starting in the cyclical sectors, the throttling of labor intensity, and the trending momentum already present in the unemployment rate, it's highly likely that we exceed that 4.5% level. And for a Federal Reserve that has clearly shown a preference for protecting the labor market over fighting inflation, that means further rate cuts should be expected.
This is the proper way to unpack the jobs report and tie it into monetary policy. So the next time the jobs report comes out and you see the media or talking heads wasting time over whether payrolls beat or missed consensus expectations, ignore that. Look at the sequence. Watch the cyclical sectors. Track the trends in the unemployment rate. And look at labor intensity. This is where the real information lies.
If you want to see this type of analysis on the jobs report every single month with the full breakdown, cyclical sequencing, historical revisions, and leading indicators, we do that inside of EPB Research as part of our operator access package. The link to learn more about what we offer in this package is in the description box below. Thank you for watching and I'll see you in the next video.