The Road to Full Employment

With major U.S. stock indexes notching new highs, long-term Treasury yields retreating from recent peaks and lower volatility, investors seem to be embracing an outlook of “just right” economic growth, steady job gains and a patient Federal Reserve committed to helping labor markets heal through ultra-easy monetary policy.

That view is understandable. The U.S. central bank has pledged to remain accommodative, until the economy reaches “maximum employment,” a shift from its historical goal of achieving a “natural” unemployment rate, below which inflation accelerates. Continued Fed dovisheness could support investor appetite for market risk and bolster expectations of lower-for-longer interest rates.

However, we expect a very different dynamic to unfold, as this business cycle progresses—namely, a hotter but shorter economic expansion, with a rapid recovery in labor markets and a burst of wage growth. Such an outcome could push up inflation rates faster than expected and prompt the Fed to raise interest rates, with important implications for portfolio positioning.

What makes us more confident about a sharp rebound in jobs? For starters, remember that this recession is unlike any in modern history—spurred by a pandemic, not by the usual cyclical excesses or tighter monetary policy. Also, the enormous monetary and fiscal policy responses helped to forestall the usual high rates of bankruptcies and credit defaults, which usually lead to restructuring and permanent job losses.

The pandemic also triggered one of the severest bouts of unemployment ever recorded, with approximately 9.7 million Americans still without jobs. Yet, this economic rebound has also spurred massive job gains in a short span, dropping the U.S. unemployment rate from 14.7% to 6.0%, according to the latest official data.

Along with the speed of rehiring, other clear indicators of economic health have surfaced. According to the latest monthly survey from the National Federation of Independent Business (NFIB), small businesses with job openings have soared to a high of 42%—20 percentage points above the nearly 50-year average. NFIB data tend to lead the U.S. employment rate by six to nine months, which suggests that the labor market could be healed by year end.

Another important factor has been the mix and quality of jobs. Manufacturing has led this recovery. The Institute for Supply Management Manufacturing Index, which is a leading indicator of economic expansion, is at its highest level since 1983, with strong readings for new orders and large backlogs. The number of new jobs coming from construction and housing-related industries is also noteworthy. Remember, in the recovery following the 2008 financial crisis, both of those sectors lagged, which helped keep inflation low—and ultimately weighed on growth. In the current recovery, those sectors lead in creating new jobs. 

The stage is set for higher wage growth. Indeed, private-sector wages and salaries have already surpassed their pre-pandemic peak—good for the workforce, but also likely to trim corporate profit margins and presage higher inflation.

That can have significant implications for investors. Higher labor costs and lower margins can hamper earnings growth, and higher interest rates could reduce the value of dividends and bond payments.

Investors should watch nonfarm payrolls. Several more months of new jobs created above a million could potentially mean full employment—defined as anyone who wants a job can get a job—by year-end. They should also consider positioning their portfolios for higher rates and inflation in the intermediate term. 

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from April 12, “For the Love of Labor.” Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this report.