Job gains reached just 199,000 in December. While a good number during normal times, it was half the 399,000 consensus estimate and our forecast of 350,000. Fortunately, upward revisions the prior two months added 141,000 more jobs to bring total net job gains to 340,000 over the last three months.

The continued climb in wages remains a concern for both businesses and the Federal Reserve. Average hourly earnings increased by 0.6% month over month in December and were up an astonishing 4.7% on a year-over-year basis. Although labor costs are climbing, workers are not necessarily seeing more in their bank accounts. As overall inflation hit a 39-year high in November, real wage gains are negative, and households' purchasing power is being squeezed.

Most sectors reported gains for the month, with leisure and hospitality adding 53,000 jobs for the month--higher than all major sectors (even health care). However, leisure and hospitality jobs, post-pandemic, are still 7.2% below precrisis levels, with government jobs next, at 4.1% below precrisis levels. Nonfarm employment has yet to recover 3.6 million of the 22.4 million jobs lost since the pandemic (see chart 1). Monthly job gains averaged 537,000 in 2021. If monthly job gains hold at that rate, the U.S. economy won't regain the jobs lost from the pandemic until sometime in the second quarter of 2023 (our December forecast).

Chart 1

Chart 2

Workers continue to have their pick of jobs, in the tightest market in decades. The unemployment rate fell again, to 3.9% from 4.2%, closer to its pre-pandemic rate of 3.5%, which gives the Fed more reason to tighten monetary policy (see chart 4). Also, 438,000 people said that they are no longer unemployed, while 168,000 people joined (or rejoined) the labor force, perhaps because they found jobs. More people entering the workforce and getting jobs is a good combination. With 651,000 more people saying that they found work, the employment-to-population ratio increased by 0.2 percentage points to 59.5%.

The large 1.3% drop in the unemployment rate for Black Americans to 6.5% in November was partially reversed, with the rate rising to 7.1% in December. Unfortunately, the gap between this rate and the white and Asian unemployment rates of 3.2% and 3.8%, respectively, remains wide. A much tighter-than-expected monetary policy could also exacerbate income inequality in 2022. The Fed indicated in 2020 that it would broaden its job market scope beyond targeting just the national unemployment rate, which tracks closely with the white unemployment rate, to include job market conditions for other demographics. With high inflation proving to be more persistent, the Fed is now apparently forced to respond--and tighten monetary policy--before other demographics, such as Black and Hispanic Americans, fully experience the benefits of a healthy economic recovery on job prospects.

That said, the job market has a long way to go before it has fully healed. The labor participation rate was flat in December, at 61.9%, a 45-year low and below its pre-pandemic rate of 63.3%, which was, itself, a 38-year low. Accounting for all the people who dropped out of the labor force since February 2020, the adjusted unemployment rate is 5.2%.

Chart 3

Chart 4

Since the pandemic began, 2.9 million people are still not working. Of these, 602,000 (21%) are unemployed, but an even larger 2.3 million (79%) have left the labor force entirely. When controlling for the age effect, we found that 42% of the drop in the labor force is structural, largely from the aging workforce, many of which have retired earlier because of the pandemic. Indeed, in the December Bureau of Labor Statistics jobs report, 34% of the labor exits since February 2020 are people 55 and older. They aren't very likely to come back. Other structural factors include the skills gap, which only worsened from the pandemic as more skilled workers either retired or quit the workforce entirely.

The remaining 58% drop in the labor force is likely temporary, largely tied to the pandemic. Childcare concerns may still be having an impact, as children under five years are not eligible for vaccines. Fear of contracting the virus is a factor, which could increase because of the omicron variant. The location mismatch remains an issue for many people who have moved away from crowded cities. The location mismatch is a bigger factor for jobs in customer-facing industries, which helps explain why those industries are still struggling to get the workers they need.

Of the 2.3 million people out of the workforce, 52% (1.15 million) are prime-age workers (ages 25-54) (see chart 6). Of those prime-age people who left the workforce, 53% are women. 276,000 prime-age women entered the workforce since November, helped by the introduction of vaccines for children five years and older. We expect to see a reversal in these gains this quarter as the omicron variant increases the number of school closures. Younger workers (ages 16-24) have returned to the workforce at a faster pace, accounting for a smaller 22% of the people who left since the pandemic began.

Chart 5

Chart 6

The Ratio Of Unemployed Per Job Opening Fell To Its Lowest On Record

The number of job openings decreased modestly in November from the previous month but remained near a record high. Job openings fell by 529,000 to 10.56 million in November, from 11.09 million in October--the largest monthly decline since April 2020. The leisure and hospitality and food accommodation industry saw the biggest monthly decline in job openings among all other sectors in November. Leisure and hospitality declined to 1.48 million openings in November from 1.75 million in October, and the food accommodation industry declined to 1.3 million openings from 1.6 million in October. This slowdown in job openings is primarily due to the pandemic worsening as employers hesitate until the health situation improves.

Despite this decline, labor demand remains high, with job openings in November 2021 still 47.5% above their 2019 average (i.e., well above the pre-pandemic level). Moreover, the ratio of unemployed per job opening was at a record low of 0.65 at the end of November 2021 (see chart 7), highlighting that it remains a workers' market.

Positively, in November, the number of hires moved up by 191,000 to 6.7 million--15% above their 2019 average pre-pandemic levels. Meanwhile the number of quits soared to a record high of 4.5 million in November, led by the leisure and hospitality and food accommodation industry, where the quits rate is at a record high. Interestingly, quits in the private industry--an important indicator of wage growth--increased to a record level in November, which is in line with the rise in the Atlanta wage growth in November.

Chart 7

Full Speed Ahead

A larger share of worker paychecks is now spent on more expensive items and not being put into their savings account. The price indices for Personal Consumption Expenditures (PCE) jumped by another 0.6% in November, advancing by 5.7% from the same month one year ago and a 39-year high. The core PCE year-over-year growth rate also increased, to 4.7% (from 4.2% in October), a 38-year high and more than 2x the Fed's inflation target of 2.0%. Indeed, while consumer spending was up 0.6% in November, most went to cover higher prices, as real consumer spending was flat for the month. With real PCE unchanged in November, the household savings rate was down by 0.2 percentage points to 6.9%, lower than the 2019 average of 7.6% and over one-fourth the stimulus-led spike of 26.6% in March.

Manufacturing activities in December signaled expansion despite higher prices and ongoing supply constraints. The Institute for Supply Management (ISM) index fell 2.4 points to 58.7% in December, down from its 18-year peak of 64.7 in March but firmly in expansion territory. The Prices Paid Index and the Supplier Deliveries Index stayed high at 68.2% and 64.9%, respectively, reflecting more expensive raw materials and slower supplier deliveries. That said, both indices were went down sharply from their November levels of 82.4 and 72.2, respectively, indicating improvements in production capacity relative to the resilient consumer demand and signs of some easing in supply constraints.

Amid an extremely tight job market, accelerated inflation readings over the past few months, and increasingly hawkish forward guidance from the Fed, we now expect three rate hikes in 2022, with liftoff (the first rate hike) at its May 3-4 Federal Open Market Committee (FOMC) meeting. (We previously expected one rate hike in September.) The minutes of the Dec. 14-15 FOMC meeting reinforced the apparently hawkish tone. Indeed, according to the minutes from the FOMC December meeting, "almost all" participants revised up their forecast for 2022 inflation "notably."

With the economic outlook much stronger than the recovery following the Great Recession, and the Fed portfolio also larger, the minutes also suggested that the Fed is more comfortable starting balance sheet runoff--called quantitative tightening (QT)--faster and earlier than the last round. The minutes noted that historical comparisons to the previous episode are less useful and that "current conditions included a stronger economic outlook, higher inflation, and a larger balance sheet and thus could warrant a potentially faster pace of policy rate normalization." A shorter weighted average maturity of the Fed's portfolio relative to the last crisis would allow for a "faster" runoff. The minutes indicated that the Fed would like the balance sheet to be in U.S. Treasuries, suggesting a quicker runoff in mortgage-backed securities to reach that goal. While the decision will be "data dependent," we suspect that the Fed will announce QT in early 2023, after three rate hikes in 2022. We do not expect the Fed to actively sell securities.

Table 1

Table 2