But Drop in Labor Force Is Bad News

• Employment growth slowed to 263,000 in September but continues to run hotter than the Federal Reserve would like.
• The unemployment rate fell to 3.5% as the labor force contracted.
• Average hourly earnings rose a moderate 0.3%.
• Job growth is slowing to a more sustainable pace, but more Fed rate hikes are coming this year.

Employment increased by 263,000 in September, according to a survey of employers from the Bureau of Labor Statistics. Job growth has slowed in 2022 as higher interest rates and high inflation weigh on the U.S. economy but remains above its long-run potential. Job growth was 315,000 in August (unrevised) and 537,000 in July, revised up from 526,000. The three-month moving average of job growth through September was 372,000, down from around 600,000 at the beginning of 2022. The private sector added 288,000 jobs in September, while government employment fell by 25,000.

The unemployment dropped in September to 3.5%, from 3.7% in August; it was 3.5% in June and July. The 3.5% rate is equal to the pre-pandemic low in early 2020 and is also the lowest unemployment rate since the late 1960s. Employment as measured in a survey of households (different from the survey of employers) increased by a solid 204,000 in September, after a big gain of 442,000 in August. Some of the decline in the unemployment rate came from more people working.

But some of the decline also came about because the number of people in the labor force-either working or looking for work-fell by 57,000 in September. The labor force participation rate-the share of adults either working or looking for work-fell to 62.3% in September. It rose from 62.2% in July to 62.4% in August, raising hopes that the tight labor market was bringing more people in off the sidelines, but the decline in September was a disappointment. The labor force participation rate has been between 62.1% and 62.4% through 2022, about a percentage point lower than it was before the pandemic, and it is unlikely to move much higher anytime soon. The post-pandemic job market looks to be structurally tighter than the pre-pandemic one.

Goods-producing industries added 44,000 jobs in September, including increases of 22,000 in manufacturing and 19,000 in construction. Private service-providing industries added 244,000 jobs over the month, including gains of 90,000 in education/health services, 83,000 in leisure/hospitality services, and 46,000 in professional/business services. There were small declines in employment in retail trade, transportation/warehousing, and financial activities.

Average hourly earnings rose 0.3% in September from August, the same pace as in August, but slightly softer than the gains in May through June. Average hourly earnings were up 5.0% in September on a year-over-year basis, down from 5.2% in August and a peak of 5.6% in March. Wage growth is slowing but remains strong. With more workers, a higher average wage, and no change in the average workweek, total labor market income rose 0.5% over the month, well above expected CPI inflation of 0.2% (to be released October 13). After falling behind inflation over the summer with very high energy prices, now incomes are rising faster than inflation toward the end of 2022, a positive for consumer spending.

Job growth has slowed substantially over the course of 2022 as economic growth has softened but remains well above its pre-pandemic pace. Wage growth has also slowed, but with the labor market still very tight it remains too hot from the Federal Reserve’s perspective. The central bank is trying to cool off growth, and inflation, by pushing interest rates higher to make it more expensive for consumers and businesses to borrow. The impact of higher rates has already shown in the housing market, with existing homes sales and single-family housing starts both down by about one-quarter from earlier this year. Job growth is moving in the right direction from the Fed’s perspective but is still too hot. The Federal Open Market Committee has already raised the federal funds rate by 3 percentage points this year, to a range of 3.00% to 3.25%, and will raise it by another percentage point through the end of 2022.

The Fed is hoping to cool off growth enough to bring inflation back down to 2% over the next year or two without causing a recession. But the central bank could easily overdo it, raising interest rates too much and pushing the U.S. economy into contraction. PNC’s baseline outlook is for weak growth in 2023 and 2024, but no outright recession, but the probability of recession over the next couple of years is around 45%, about double what it was prior to the Russian invasion of Ukraine.

PNC expects job growth to continue to slow in the near term as the impact of higher interest rates continues to filter its way through the economy, with employment flat by the middle of next year, before picking up again in 2024. PNC expects the unemployment rate to gradually increase and end 2023 at around 4.3%.