investment viewpoints

What the latest US jobs data say about recession risk

What the latest US jobs data say about recession risk
Florian Ielpo, PhD - Head of Macro, Multi asset

Florian Ielpo, PhD

Head of Macro, Multi asset

In the latest instalment of Simply put, where we make macro calls with a multi-asset perspective, we analyse the surprising strength of the US services sector and explain what it tells us about the risk of a recession.  


Need to know:

  • The strength of January’s US jobs report has shaken investors’ perception that a soft landing can be achieved
  • However, what hides behind the figure is the remarkable strength of the services sector
  • That sector is the worst of all indicators where risk of recession is concerned, as evidenced by historical analysis. We advise investors to not pay it too much attention for now


Reasonable doubt towards a soft landing

The US employment report for January has introduced a reasonable doubt in the mind of investors. Markets seemed largely convinced that the Federal Reserve (Fed) was the next central bank to end its hiking cycle, and that the retreat of inflation was a done deal. But news that the US economy added more than 500,000 jobs last month prompted investors to think again.

In the current context of high economic uncertainty, this surprise is far from welcome and markets reacted strongly. Looking at the details of the numbers in the jobs report, not all sectors have been creating openings and most of the job creation originated in the services sector. The ISM non-manufacturing index bouncing back from sub-50 levels, indicating contraction, to the growth territory of 55.2 is casting doubt on the ’shallow’ recession that has been expected by many.

Is the case for a soft landing now gone? Does this services-sector strength mean that the economy does not need to land at all? An interesting perspective on that question can be found among the real business-cycle theorists of the late 70s. Here is our take on whether their message has aged well or not.


Strong services growth

The problem with the US employment report is not the headline number of new jobs, but its composition. The report shows a 443,000 increase in private payrolls versus the 190,000 expected. The US added 517,000 jobs in January once public jobs are added: a surprisingly strong number indeed.

Figure 1 provides a breakdown of the top- and bottom-10 contributing sectors. It shows that some sectors laid off workers in January, mostly in different industry sectors such as in the transportation, healthcare or in the information-technology sectors. These layoffs are consistent with large companies’ announcements during the Q4 earnings season.

However, the aggregate number remained low, at 27,000 jobs lost, compared to job creations. What is interesting that most of these new jobs originated in the services sector. We can see that 338,000 of the 517,000 jobs came from that sector, and when looking at long-term trends, these additions are contributing to replacing the workers lost since the 2020 pandemic, which resulted in 17 million layoffs across services sectors.

According to our estimates, the services sector is still short 1.8 million jobs, so these 300,000-plus hires seems small in contrast. So, it is doing well and the ISM non-manufacturing index does not say otherwise. This is what was behind January’s jobs-growth surprise. Does it mean that the risk of a recession has been neutralised?


FIG 1. US job creation per sector in January 2023

Multi-Asset-simply-put-Job creation-01.svg

Source: Bloomberg, LOIM


The reality of the business cycle

The services sector is the number one employer in most of the northern-hemisphere economies, while also accounting for more than half of GDP creation. And yet, very few economists spend time studying its dynamics. As Fed Chair Jerome Powell would say, this is simply “rational inattention”.

Back in the 1970s, American economists, gathered under the real business-cycle banner, announced the first empirically and theoretically grounded study of the business cycle. One of their starting points is presented in Figure 2. It illustrates that around recessions, all sectors contributing to GDP do slow down, but not by the same extent and not with the same timing. Some are earlier to enter recession, such as residential investment, and others are either late or show a very limited contraction, such as the services sector.

As shown in Figure 2, even if the services sector is systemically large in most of the developed economies, its lack of volatility makes it one of the worst places to look for evidence of strengthening recessionary forces. None of the time series that are selected econometrically to construct our growth nowcasting signal are tied to that sector: the real business-cycle message has survived all the econometric analysis we have deployed to build our indicators.

Industry and residential investment are where signs of recession can be found, not the services sector. Analysis by economists Robert Hodrick and Edward Prescott – the very same who created the Hodrick–Prescott filter, which removes short-term fluctuations in business-cycle data – should still be seen as a beacon in the current macro fog. We should not put too much stock in services-related jobs data, as it is probably the least likely place where a recession is going to materialise first.


FIG 2. Average GDP growth per sector around recession periods

Multi-Asset-simply-put-Avg GDP-01.svg

Source: LOIM, Bloomberg.

  Simply put, the US jobs report shows the current strength of the services sector. However, when trying to assess the risk of a recession, investors should focus elsewhere.  


Macro/Nowcasting Corner

The most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary policy surprises are designed to keep track of the latest macro drivers making markets tick. 

Our nowcasting indicators currently point to:

  • The US growth nowcaster is in a recession zone but its diffusion index has been rising steadily since the start of the month. It does not change the overall low-growth message from our growth indicator, but is an early sign of change in the direction of macro data
  • Inflation surprises should continue to be negative across the board. Our Eurozone indicator declined again this week: the European Central Bank’s hawkish case seems to be easing
  • Our monetary policy nowcasting indicator remains between 45% and 55%, remaining stable over the past week

World Growth Nowcaster: Long-Term (left) and Recent Evolution (right)

Multi-Asset-simply-put-Growth nowcaster-06 Feb-01.svg

World Inflation Nowcaster: Long-Term (left) and Recent Evolution (right)

Multi-Asset-simply-put-Inflation nowcaster-06 Feb-01.svg

World Monetary Policy Nowcaster: Long-Term (left) and Recent Evolution (right)

 Multi-Asset-simply-put-Monetary Policy nowcaster-06 Feb-01.svg

Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The Nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).


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