Both the US and the Eurozone released some fundamental documents on March 31, 2023: the US released the PCE (Personal Consumption Expenditure), while the Eurozone released its CPI (Consumer Price Index) and unemployment rate.
For what concerns the Eurozone, data show that the CPI decreased to 6.9% from 8.5% of February – the lowest level since February 2022.
Source: Eurostat
For what concerns the unemployment rate in teh Eurozone, it is stable – at 6.6%.
The PCE for February was 4.6% – slightly below the January level of 4.7%, but still far from the Fed target of 2%.
All these indexes are strictly correlated to inflation. Let’s see why, and how this can impact the labor market.
What are the PCE and the CPI – Definitions and differences
Personal Consumption Expenditure indicates how much people spend for goods and services. As inflation rises, the index rises – since prices increase. Actually, this is one of the most used indexes to understand the inflation level of an economy.
Latest PCE. Source: US Bureau of Economic Analysis
As shown in the picture, people started saving more (the black line), and spending more (as indicated by the orange column), despite wages didn't increase according to the higher inflation that caused an increase in prices.
The Consumer Price Index is very similar, since also this index measures the change in expenditure because of the increasing or decreasing prices of goods and services.
The difference between PCE and CPI is that the PCE is more complete – since it also considers data gathered from suppliers, while the CPI is focused on consumers.
The correlation between inflation and the labor market
The correlation between inflation and the labor market is an inverse correlation – that is, inflation is usually higher when unemployment is low.
When unemployment is low, employers usually have to raise wages and offer better benefits to attract more skilled workers.
On the contrary, when unemployment is high, employers don’t need to deal with high competition.
Economists used the so-called Phillips Curve to explain this phenomenon:
Source: Wikimedia Commons
This theory was developed by the economist William Phillips and despite it's often considered to understand macroeconomic events, it was also questioned since some analysts that it doesn't hold in the long run - and sometimes it doesn't work even in the short run.
But if you want to understand more about this theory, here's a brief explanation: during times of economic growth, inflation rises. While inflation rises, the unemployment rate starts to decrease.
In spite of controversial opinions regarding the correlation between inflation and unemployment, the reasoning behind the theory is logic and it's something we can observe across different periods in history.
As we said in our past newsletters, a way to fight high inflation often used by governmental regulatory bodies is to raise interest rates. This is exactly what’s happening now.
In the short run, it is hard to assess what are the consequences of this choice, and data needs to be analyzed periodically in order for governments to adjust their decisions if needed.
As reported by Reuters, the number of claims for unemployment benefits witnessed a very moderated rise. At the same time, the fact that higher interest rates are negatively affecting banks and businesses might change this trend.
The US labor market is still tight: when a labor market is defined as “tight” this means that the supply of jobs is higher than the amount of workers available.
So, as of now, it seems that the measures taken by the Fed are not implying any major change. But, as we said, the harder conditions for businesses – which are actually the suppliers of jobs – might change the current situation of the labor market.
How tech layoffs impact the current labor market
The hundreds of thousands of tech layoffs that hit the market seem to have no impact on the market as a whole.
This might have two good explanations: workers in the tech industry are usually highly skilled and can use their skills across different sectors; in a tight labor market, unemployed workers are easily absorbed.
If we look at the big picture, we can read a slightly different story.
US consumers are already spending less and saving more. This might be the result of a general panic created by the current banking crisis, but we have to consider also that the unemployment rate is already higher than expected, and that the number of unemployment benefits claims is already higher than forecasts.
To get back to our discussion about the correlation between inflation and unemployment, I created this chart taking data from the US Bureau of Labor Statistics:
What does this chart tell us?
The first conclusion we can draw is that yes, unemployment and inflation are usually correlated.
Second, when unemployment starts to rise - and, to be more visual, the blue line surpasses the red line - there is usually a recession.
A recession obviously normalize inflation - credit is tight, unemployment is high, interest rates fall to allow the economy to recover. And the cycle starts again.
Now, even if the highest number of layoffs is registered in the tech industry - and more specifically, in the fintech sector, the concern is that layoffs could spread across different industries, for a few reasons:
- First, higher interest rates causes issues to businesses and tighten credit,
- The current banking crisis is just a confirmation of the issues caused by rates,
- If the suppliers of jobs are in trouble, unemployment starts to rise.
Final thoughts
It’s maybe too early to assess the effects of rising interest rates on inflation and the labor market, but there are already a few points we can consider:
- Unemployment is higher than expected (3.6% in the US, more than the expected 3.4%),
- The claims for unemployment benefits claims already rose (+7000),
- Consumers began to save more (4.6% of income in February, 0.2% more than in January).
These might be just a few signs that further confirm the expectations regarding a recession – already in 2023.
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