The overheated labor market during the epidemic is slowing down, but the sharply deteriorating risks are increasing every day.

Nick Timiraos, the financial journalist known as the "New Fed Communications Agency," recently wrote that even if the labor market cools down slowly, the US economy may still fall into recession.

Non-farm data shows that the unemployment rate has risen from a historical low of 3.4% a year ago to 4% in May, close to the full employment level economists believe. However, historically, once the unemployment rate rises half a percentage point from its recent low, it will continue to rise significantly, causing the economy to fall into recession. Timiraos quoted Ernie Tedeschi, a former Biden administration economist, as saying "although the current economy seems to be in a sustainable and moderate state, there is still considerable uncertainty due to the fact that the US economy rarely reaches or approaches full employment."

Timiraos quoted former Biden administration economist Ernie Tedeschi as saying:

"Although the current economy seems to be in a sustainable and moderate state, there is still considerable uncertainty due to the fact that the U.S. economy rarely reaches or approaches full employment."

This Friday, the US will release its June non-farm employment report.

Policy balance dilemma: suppressing inflation or stabilizing employment?

Timiraos believes the biggest challenge the Fed currently faces is finding a balance between controlling inflation and maintaining healthy employment.

In May, the PCE price index rose 2.6% year-on-year, but is still above the Fed's 2% target. Fed officials say they can wait to lower interest rates as long as the labor market remains healthy.

However, considering the slowdown in consumer spending and if the labor market continues to cool down, this momentum will be difficult to stop, and the Fed may advance the timing of rate cuts to prevent the risk of economic recession.

In fact, several Fed officials have already said that the labor market is severely unbalanced.

According to relevant data cited by the media, since the Fed began raising interest rates in March 2022, the per capita vacancy rate in the labor market has dropped from 2 vacancies/job seeker to 1.2 vacancies/job seeker in April this year, reaching the level before the COVID-19 epidemic - this is almost entirely caused by a reduction in job vacancies rather than an increase in unemployment rate.

This means that the seemingly gradually balanced labor market data is not driven by employment growth, but by a reduction in vacant positions.

In addition, the enterprise survey results in the non-farm report show that employment positions have increased by 2.8 million in the past year, while the household survey results show that employment has only increased by 216,000. The polarization of the two sets of data may mean that employment positions created by new enterprises are overestimated, or employment positions lost by failed enterprises are underestimated.

The article also cites observations by Goldman Sachs economists that the ratio of first-time job seekers to jobs has decreased and the number of layoffs has increased, which may also indicate the fragility of the job market.

Timiraos concludes:"The Fed needs to take the current state of the labor market seriously, even though it is not deteriorating rapidly, but it may not be as strong as it appears in the data."

For financial markets, what are the risks?

The biggest concern of the market for the possible sharp deterioration of employment is economic recession, and in the end, the Fed may need to boost the economy by lowering interest rates, rather than achieving a soft landing.

Matt Stucky, chief investment portfolio manager at Northwestern Mutual Wealth Management, believes that the risk of economic recession is rising:

"The labor market is becoming more and more unbalanced, and future employment will not keep pace with population growth, which means that the participation rate will continue to decline."

Investors should prepare for moderate recession asset allocation in the next 12-18 months.

However, Luke Tilley, chief economist at Wilmington Trust, is relatively optimistic. He believes that as economic growth slows and inflation continues to cool, the rise of the S&P will expand, opening the door to rate cuts.

Therefore, Tilley is also bullish on the relatively underperforming S&P component stocks, and expects the US economy to begin to decline only after 18 months when interest rates reach their peak in 2026.

Editor/Somer