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Chief Global Economist, Deloitte Touche Tohmatsu
United States
Dr. Kalish is the Chief Global Economist of Deloitte Touche Tohmatsu Ltd. He is a specialist in global economic issues as well as the effects of economic, demographic, and social trends on the global business environment. He advises Deloitte clients as well as Deloitte’s leadership on economic issues and their impact on business strategy. In addition, he has given numerous presentations to corporations and trade organizations on topics related to the global economy. He is widely traveled and has given presentations in 47 countries on six continents. He has been quoted by the Wall Street Journal, The Economist, and The Financial Times. Dr. Kalish holds a bachelor’s degree in economics from Vassar College and a PhD in international economics from Johns Hopkins University.
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Claudia Sahm herself has said that the rule named for her is not a law of physics. Rather, it is a pattern that has been consistent, but might not continue. Thus, it ought to be taken with a grain of salt. Still, the unemployment rate has risen rapidly in recent months. In fact, Dr. Sahm recently said that now is a good time for the Federal Reserve to cut interest rates. She said: “My baseline is not recession. But it’s a real risk, and I do not understand why the Fed is pushing that risk. The worst possible outcome at this point is for the Fed to cause an unnecessary recession.” She appears to be saying that the ball is in the Fed’s court.
In any event, let’s consider the latest jobs report. The US government releases a jobs report based on two surveys: One is a survey of establishments; the other a survey of households. The establishment survey found that 206,000 new jobs were created in June—a very strong number, but the second slowest job growth in the past seven months. In other words, the job market appears to be slowing while remaining relatively strong.
By industry, there was strong growth in construction but a decline in employment in the manufacturing sector. In addition, employment declined in retailing and increased only marginally in financial services, information, and wholesale trade. Moreover, employment fell sharply in professional and business services, largely reflecting a big decline in employment in temporary job services. In addition, there was a very small increase in employment in leisure and hospitality. On the other hand, there was a big increase in employment in health care and social assistance as well as in state and local government. Overall, job growth was relatively concentrated in a small number of industries.
Meanwhile, the establishment survey also included data on wages. The government reported that average hourly earnings were up only 3.9% in June versus a year earlier, the smallest increase since June 2021. This suggests that the tightness in the job market is easing. That bodes well for a continued deceleration in inflation. Indeed, the principal worry of the Federal Reserve in the past year has been the tightness of the job market and its impact on wages.
Finally, the household survey, which includes data on self-employment, found that the size of the labor force increased considerably faster than the working-age population. That is, the participation rate increased. Yet employment increased more slowly than the labor force, resulting in a slight increase in the unemployment rate from 4% in May to 4.1% in June.
What will the Federal Reserve make of this report? First, they might take note that the Sahm Rule has been activated. Second, they may note that, although employment grew at a healthy pace, it grew more slowly than in recent months and the growth was concentrated in only a few industries. Third, they may note that wage inflation has decelerated to the lowest level in three years. Given that the Fed’s Congressional mandate is to minimize inflation and maximize employment, this data suggests that an easing of monetary policy could come soon. Of course, much will depend on what the next set of inflation numbers indicate.
Let’s look at the details: In May, real disposable personal income (income after inflation and taxes) was up 0.5% from the previous month, reflecting strong increases in wages after inflation. In addition, real personal consumption expenditures were up 0.3% from the previous month. The latter included a 1.1% real increase in spending on durable goods, a 0.3% gain for non-durable goods, and a 0.1% increase for services.
Regarding the PCE-deflator, overall prices were up 2.6% from a year earlier. When volatile food and energy prices are excluded, core prices were also up 2.6% from a year earlier, the lowest rate of core inflation since March 2021. By category, prices were down a sharp 3.2% for durable goods, up 1.6% for non-durable goods, and up 3.9% for services. While the latter number is one of the lowest in three years, it remains too high for the Fed’s comfort. Services are labor-intensive and wages continue to rise sharply amid a tight labor market.
Economists are divided as to when the Fed may start to cut rates. Some argue that the very low level of core inflation means that the Fed has largely achieved its goal. Others worry, however, that persistent services inflation will not abate until the economy softens. They suggest that sustained tight monetary policy will be needed to facilitate such an outcome.
Let’s look at the data: In June, Eurozone consumer prices were up 2.5% from a year earlier, down from a rate of 2.6% in May but higher than the 2.4% inflation recorded in both March and April. When volatile food and energy prices are excluded, core prices were up 2.9% in June versus a year earlier, the same rate as in March and May and higher than the 2.7% rate recorded in April. In other words, core inflation has stabilized above the ECB target.
One factor that explains the relatively low headline inflation rate is the 0.2% rate of inflation for energy. Food prices, meanwhile, were up 2.5% in June from a year earlier. Prices of non-energy industrial products were up a mere 0.7% in June from a year earlier while prices of services were up 4.1%. The latter number has barely moved in the last six months. This persistence of service inflation likely reflects the labor-intensive nature of services and the fact that tight labor markets are generating big wage increases. This is the principal concern of the ECB. Meanwhile, the European Union (EU) released data on employment in the Eurozone. It found that the Eurozone unemployment rate remained unchanged in May at an historically low 6.4%.
The recent persistence of service inflation could be attributable, in part, to the start of the tourism season and to the intense demand for major sporting and entertainment events (think Taylor Swift). Still, the ECB will closely watch the labor market for signs of rising or falling demand. It will also look at other factors such as labor productivity and migration, both of which can have a big impact on wages. ECB President Lagarde said that the policy committee will closely watch data, noting that it will “take time” to determine the direction of things.
Interestingly, BIS research indicates that the ratio of service prices to goods prices remains below the pre-pandemic level. This reflects the impact of the spurt in goods prices early in the pandemic. The BIS suggested that the current high inflation in services reflects a trend toward restoring the traditional relationship between the prices of services and goods. Unless there is further goods price deflation, it is likely that this process will entail overall inflation remaining above pre-pandemic levels for some time.
In addition, the BIS said that the global financial system is at risk from persistent high fiscal deficits as well as troubles in the commercial property market. Regarding fiscal policy, it noted that the trajectory of fiscal policy in major economies is unsustainable. Although investors have not yet reacted adversely to current fiscal trends, this could change, thereby wreaking havoc in financial markets and creating difficult choices for central banks. A top BIS official said that “we know that things look sustainable until suddenly they no longer do—that is how markets work.” Fiscal expansion played a role in the post-pandemic rebound of major economies. Yet, when policy tightens, it could cause a slowdown in growth.
The global PMI for manufacturing was nearly unchanged in June at 50.9, indicating modest growth of activity. The survey found that output and new orders continued growing but at a slower pace. Export orders declined. However, employment and input and output pricing all accelerated. The acceleration in prices raises questions about inflationary trends. The PMI for manufacturers of consumer goods was relatively high while that of capital goods producers was relatively low. The latter potentially bodes poorly for investment spending.
The countries with the highest manufacturing PMIs were India, Russia, Vietnam, Greece, and Taiwan. The lowest were Germany, Austria, Poland, and Czechia. Of the 31 countries analyzed, 19 had PMIs above 50, indicating growth, while 10 had PMIs below 50. Two countries had PMIs at 50. The countries of Asia as well as the United States had relatively strong growth while Europe excluding the United Kingdom saw a sizable decline in activity.
Here are a couple of key points inferred from the PMI data. First, the German manufacturing sector PMI fell to 43.5 in June, indicating very rapid decline. This led S&P Global to ask, “Will this downturn in manufacturing never end? It will, but apparently it is going to take longer than expected.” S&P noted that there was a sharp decline in new orders and export orders. However, sentiment improved, suggesting that companies see light at the end of the tunnel. The sharp decline in export orders is especially concerning and might reflect increased competition from Chinese companies.
Another interesting aspect of the global data concerns Taiwan. It’s manufacturing PMI increased sharply from 50.9 in May to 53.2 in June, hitting a two-year high. This dramatic improvement reflected a surge in demand for Taiwan’s globally competitive IT products, a reflection of the surge in AI investment. Companies were able to boost output without boosting employment because of substantial improvements in labor productivity. Still, facing labor constraints, companies have been forced to increase prices. Also, the manufacturing PMI in Vietnam surged, rising from 50.3 in May to 54.7 in June. This likely reflects an acceleration in supply chain shifts from China to Southeast Asia.
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Chief Global Economist, Deloitte Touche Tohmatsu
United States
Dr. Kalish is the Chief Global Economist of Deloitte Touche Tohmatsu Ltd. He is a specialist in global economic issues as well as the effects of economic, demographic, and social trends on the global business environment. He advises Deloitte clients as well as Deloitte’s leadership on economic issues and their impact on business strategy. In addition, he has given numerous presentations to corporations and trade organizations on topics related to the global economy. He is widely traveled and has given presentations in 47 countries on six continents. He has been quoted by the Wall Street Journal, The Economist, and The Financial Times. Dr. Kalish holds a bachelor’s degree in economics from Vassar College and a PhD in international economics from Johns Hopkins University.
Cover image by: Sofia Sergi
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