With Unemployment Rate Down to 3.8%

• The U.S. economy added 678,000 jobs in February, well above the consensus expectation of 400,000.
• The unemployment rate fell to 3.8% in February from 4.0% in January. The labor force participation rate rose slightly to 62.3%.
• The average workweek was steady in February from January, while average hourly earnings were essentially flat.
• The report was very good and supports an increase in the federal funds rate when the FOMC meets in mid-March. However, with Ukraine adding to uncertainty, the FOMC will only increase the rate by a quarter of a percentage point.
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The U.S. economy added 678,000 jobs in February, according to a survey of employers from the Bureau of Labor Statistics. This was well above the consensus expectation for an increase of 400,000, and the best month for job growth since July 2021. Job growth in January was revised slightly higher, to 481,000 from 467,000, while there was a more significant upward revision to job growth in December, to 588,000 from 510,000, for a combined upward revision of 92,000. The three-month moving average of job growth through February was an excellent 580,000, close to the pace of the past year. Private-sector employment increased by 564,000 in February, while government employment rose by 24,000.

Employment in February was 2.1 million, or 1.3%, below its pre-pandemic level. The U.S. economy has added back about 20 million of the 22 million jobs lost in March and April 2020 at the start of the pandemic.

The unemployment rate fell to 3.8% in February from 4.0% in January, a new post-pandemic low. The unemployment rate was at 3.5% in early 2020 before the pandemic, and then rose to 14.7% in April of 2020. Employment in a survey of households (different from the survey of employers) increased by 548,000 in February. The labor force-the number of adults either working or looking for work-rose by 304,000 in February, while the share of adults in the labor force increased slightly to 62.3% in February from 62.2% in January. The labor force participation rate was above 63% before the pandemic, so the workforce now is much smaller than it was a couple of years ago, explaining why businesses are having such difficulties in finding workers.

Goods-producing industries added 105,000 jobs in February, the biggest gain since March 2021. There were increases of 60,000 in construction employment and 36,000 in manufacturing employment. Private service-providing industries added 549,000 jobs over the month, with big gains in leisure/hospitality services (+179,000), education/health services (+112,000), professional/business services (+95,000), and transportation/warehousing (+48,000). Employment in leisure/hospitality suffered disproportionately during the downturn, falling by almost one-half. Since then, the industry has added back almost 7 million jobs, but employment is still 9% below its pre-pandemic level. Government employment increased by 24,000 in February, with all of that coming from state and local jobs.

The average workweek increased to 34.7 hours in February, from 34.6 hours in January. Somewhat surprisingly average hourly earnings in the private sector increased by only one cent over the month, to $31.58. The average wage had been increasing at around 0.5% to 0.6% in recent months as businesses raised pay to attract new workers and retain their current ones amid the very tight labor market. Even with no increase in February, average hourly earnings were up more than 5% from one year earlier. The flat average wage in February is likely a fluke, and the tight labor market will drive strong wage growth in the months ahead. With more jobs, a slightly longer workweek, and a flat average wage, aggregate labor market income was up 0.8% over the month, which should outpace even high inflation of around 0.6% in February (CPI to be released on March 10).

The February jobs report was very good. Job growth was strong and broad-based across industries, while the unemployment rate fell even as the labor force expanded. The only weak spot was flat average hourly earnings but given the tight labor market that is likely an anomaly, and strong wage growth should resume in March.

Under normal circumstances, the rapid improvement in the labor market in recent months, accompanied by high inflation, would have the Federal Reserve set to raise the federal funds rate quickly. But the Russian invasion of Ukraine has disrupted the outlook, and Fed Chair Powell has said that the Federal Open Market Committee will only raise the fed funds rate by 25 basis points when it meets on March 15 and 16, to a range of 0.25% to 0.50%. PNC expects the FOMC to raise the fed funds rate to a range of 1.25% to 1.50% by the end of this year, and to a range of 2.00% to 2.25% by mid-2023. But if inflation does not slow as the Fed expects it to, perhaps due to higher energy prices in the wake of the Ukraine invasion, the FOMC would not be afraid to raise the federal funds rate more aggressively.

PNC expects job growth to average better than 300,000 per month throughout 2022, well above the pre-pandemic pace, although job growth will slow over the course of the year. Employment should return to its pre-pandemic level by the third quarter of 2022. The unemployment should return to its pre-pandemic level of 3.5% in mid-2022. An open question is what happens to the labor force; this outlook assumes that some, but not all, of the people who left the labor force return as government aid and the pandemic recede. But weaker labor force growth would weigh on near-term hiring.

Even with the strong jobs report the S&P 500 down by about 1% over concerns about Ukraine. The yield on the 10-year Treasury note is down by about 10 basis points to 1.75%, while the yield on the 3-month T-bill is flat at 0.34%. The price of a barrel of West Texas Intermediate crude oil is up almost 4% to $112, the highest price since 2008. The U.S. dollar has strengthened against a basket of currencies.

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