Labour – CC&L Financial Group Ltd.

Perceptions of UK labour market “resilience” rest partly on continued growth in the payrolled employees series, based on PAYE data. This series, however, is likely to have been boosted by a rise in the proportion of self-employed people included in PAYE.

Labour Force Survey (LFS) employment is, at least in concept, the most comprehensive measure of employed people, including all employees and self-employed. The payrolled employees series covers most employees* along with self-employed people who receive pay through PAYE. The latter group includes business owners who choose to draw a salary, contractors on the payroll of the client and self-employed people with second jobs as employees.

LFS employment peaked in the three months to April 2023, standing 150,000 below that level in the three months to January. This is consistent with GDP / gross value added data indicating a recession starting in Q2 2023.

The payrolled employees series, by contrast, grew by 270,000 over the same interval.

This continues a longer-term divergence. LFS employment in the latest three months was 85,000 above its pre-pandemic peak, reached in the three months to February 2020. Payrolled employees have increased by 1.3 million since then – see chart 1.

Chart 1

Chart 1 showing UK Employment Measures (mn, 3m ma)

There are two reasons for suspecting that the payrolled employees series has been swollen by increased PAYE coverage of the self-employed. First, reform of IR35 rules in the private sector in April 2021 are likely to have resulted in some contractors being moved onto clients’ payrolls.

Secondly, the number of employee jobs has risen by more than employee numbers, suggesting a rise in multiple job-holding**. This may have resulted in some people identifying as self-employed in the LFS being picked up in PAYE.

LFS self-employment was 4.33 million in the three months to January. A rough guide to the number included in PAYE is the difference between the payrolled employees series and the LFS measure of employees – 1.6 million.

Chart 2 shows that the latter differential mirrored changes in LFS self-employment until early 2021. It then embarked on a rising trend while LFS self-employment moved sideways. The timing is consistent with an impact from the IR35 reform.

Chart 2

Chart 2 showing UK LFS Self-Employment (mn, 3m ma) & Payrolled Employees / LFS Employees Differential (mn, 3m ma)

The rise in the payrolled employees / LFS employees differential is unlikely to be solely attributable to increased PAYE coverage of the self-employed. The decline in quality of LFS data due to a falling response rate may have been associated with underrecording of growth in employee numbers.

The payrolled employees series, nevertheless, warrants a health warning and its relative strength should be at least partly discounted, particularly as it jars with other evidence including an ongoing fall in vacancies, rising claimant unemployment, weak REC jobs reports and a recent increase in redundancies.

Addendum: Falling US temporary help services employment has been a harbinger of weakness in aggregate payrolls historically. UK LFS temporary employment has a patchier record as a leading indicator but a plunge since the summer is eye-catching – chart 3.

Chart 3

Chart 3 showing UK LFS Temporary Employees (mn, 3m ma)

*It does not include employees of companies paying below the national insurance lower earnings limit.

**The Workforce Jobs dataset shows a rise in employee jobs of 1.79 million between Q4 2019 and Q4 2023 versus a 955,000 increase in the LFS measure of employee numbers over the same period.

US September non-farm payrolls blew through the consensus expectation but the totality of evidence from the employment report suggests that the labour market continues to cool.

Including upward revisions to the prior two months, 455,000 jobs were added to the payrolls tally in September. However, this follows three weak months when the revisions-adjusted gain averaged 105,000 – see chart 1.

Chart 1

The alternative household survey employment measure – which counts people rather than jobs – grew at half the pace of payrolls in the three months to September – chart 2.

Chart 2

The relative strength of payrolls partly reflects a further rise in multiple job-holding, which is approaching its pre-pandemic peak, i.e. the relative boost may be ending – chart 3.

Chart 3

Stepping back, stronger growth of payrolls than GDP since end-2021 represents a catch-up following a big undershoot of trend during the pandemic – chart 4.

Chart 4

The catch-up appears complete, suggesting that payrolls will resume slower growth than GDP. The slope of the trend line implies a fall in payrolls if GDP growth declines below 1% annualised.

Temporary help jobs have led at prior peaks and troughs in payrolls and continued to decline in September – chart 5.

Chart 5

The unemployment rate, meanwhile, held at its higher August level, with the demographic breakdown showing a sharp jump among prime-age males – chart 6.

Chart 6

Verdict: neutral / negative – headline surprise offset by weaker internals.

A post in May suggested that UK employment would embark on a sustained decline in Q2. This was based on the stock of vacancies having fallen 17% from its 12-month peak – declines of more than 15% historically were always associated with sustained employment falls.

Labour Force Survey employment fell by 207,000 in the three months centred on June from three months earlier, while the workforce jobs measure (of positions rather than people) was down by 153,000 between March and June.

Vacancies have continued to collapse, with the August stock down by 23% from its 12-month high and 29% below the April 2022 peak – see chart 1.

Chart 1

The three-month average unemployment rate, meanwhile, rose further to 4.3% in July versus an August 2022 low of 3.5%, confirming a Sahm rule recession signal (an increase of more than 0.5 pp from the 12-month minimum) – chart 2.

Chart 2

A July post noted that the Sahm rule has an imperfect record as an indicator of UK recessions but signals were always associated with a slowdown in average earnings growth.

Annual growth of regular earnings ticked down from 8.0% in June to 7.8% in July, while median pay growth in the more timely PAYE dataset eased to 6.7% in August – chart 3. (Caveat: the PAYE numbers are subject to significant revision.)

Chart 3

In light of the above, claims that the latest labour market news is “mixed” and shouldn’t deflect the MPC from another rate hike next week are odd and appear to reflect confirmation bias.

Money / credit contraction argues that current policy is much too restrictive. The ongoing collapse in vacancies and faster-than-expected deterioration in more lagging labour market indicators are consistent with this interpretation.

MPC member Catherine Mann argues for erring on the side of overtightening because rates can be cut swiftly if a mistake becomes apparent. If only the economic damage from bad policy-making were so easily reversed.

A bottoming out of the global stockbuilding cycle could be associated with a near-term recovery in manufacturing survey indicators. Money trends suggest that any revival will be modest / temporary and offset by wider economic weakness.

Economic news has been unusually mixed since end-2021, with GDP weakness contrasting with labour market strength and manufacturing deterioration offset by services resilience. Confusing signals have contributed to market hopes of a “soft landing”.

Sectoral and regional divergences may persist in H2 2023. The expectation here is that manufacturing survey weakness will abate but labour market data will worsen significantly. Money trends continue to cast strong doubt on soft landing hopes. Europe is likely to underperform the US.

The US ISM manufacturing new orders index – a widely watched indicator of industrial momentum – hit a low of 42.5 in January and retested this level in May before recovering to 45.6 in June.

Reasons for expecting a further rise include:

The index has been in the 40s since September 2022 and the mean duration of sub-50 periods historically was eight months (ignoring episodes of three months or less).
The global stockbuilding cycle remains on track to bottom out during H2 2023 and lows historically were usually preceded by a recovery in US / global manufacturing new orders.
Recent price falls for raw materials and other production inputs may further incentivise firms to step up purchasing to maintain or replenish inventories.

Korean manufacturing is a bellwether of US / global trends and the latest Federation of Korean Industries survey reported a marked improvement in optimism, consistent with ISM new orders moving back above 50 – see chart 1.

Chart 1

Sustained recoveries in ISM new orders from the mid 40s into expansionary territory historically occurred against a backdrop of positive and / or rising six-month real narrow money* momentum. Current trends are unfavourable, with momentum still significantly negative and moving sideways – chart 2.

Chart 2

Examples of recoveries to above 50 without a supportive monetary backdrop include 1970 and 1989-90. In both cases the rise was modest (peaking below 55), short-lived and followed by a decline to a lower low. The recovery in 1970 occurred within an NBER-defined recession and in 1989-90 just before one.

An ISM rebound might not be mirrored by much if any revival in European manufacturing surveys. Money trends are even weaker than in the US, while the stockbuilding adjustment started later in the Eurozone and probably has further to run – charts 3 and 4.

Chart 3

Chart 4

*Narrow money definition used here = M1A = currency + demand deposits.

The Sahm rule states that the (US) economy is likely to be in recession if a three-month moving average of the unemployment rate is 0.5 pp or more above its minimum in the prior 12 months.

The rule identified all 12 US recessions since 1950 but gave two false positive signals based on current (i.e., revised) unemployment rate data (1959 and 2003) and four based on real-time data (additionally 1967 and 1976).

The signal occurred after the start date of the recession in all 12 cases, with a maximum delay of seven months* (in the 1973-75 recession).

The Sahm condition hasn’t yet been met in the US – the unemployment rate three-month average was 3.6% in June versus a 12-month minimum of 3.5%.

The rule has, however, triggered a warning in the UK, where the jobless rate averaged 4.0% over March-May, up from 3.5% over June-August 2022.

UK Sahm rule warnings occurred on nine previous occasions since 1965, six of which were associated with GDP contractions.

The Sahm signal is another indication that the UK economy is already in recession – see previous post – but a stronger message is that earnings growth is about to slow.

Annual growth of average earnings fell after the Sahm signal in eight of the nine cases, the exception being the 2020 covid recession, when earnings numbers were heavily distorted by composition effects – see chart 1.

Chart 1

Previous generations of monetary policy-makers understood the dangers of basing decisions on the latest inflation and / or earnings data, which reflect monetary conditions 18 months or more ago.

The current reactive approach, apparently endorsed by the economics consensus, may partly reflect mythology about a 1970s “wage / price spiral”. Rather than causing each other, high wage growth and inflation were dual symptoms of sustained double-digit broad money expansion.

The monetarist case is summarised by chart 2, showing that earnings growth is almost coincident with core inflation whereas broad money expansion displays a long lead. (The correlations with core inflation are maximised with lags of four months for earnings growth and 24 months for money growth.)

Chart 2

Recent monetary weakness argues that core inflation and wage growth will be much lower by late 2024; the Sahm rule signals that the decline is about to start.

*Eight months taking into account a one-month reporting lag.

Commentators have expressed scepticism about a large monthly fall in the “experimental” PAYE employees measure in April (136,000 or 0.45%, equivalent to a 700,000 drop in US non-farm payrolls).

It is true that initial estimates are often revised significantly but the largest upward adjustment to the month-on-month change historically was 121,000, relating to a pandemic-distorted month (March 2021*). The mean absolute revision over the last year was 34,000.

The recent trend, moreover, has been for downgrades – the initially estimated month-on-month change has been revised lower for five of the last six months.

The reported fall is consistent with the latest KPMG / REC Report on Jobs: the permanent placements index in April was the lowest since the start of 2021 and the PAYE measure last declined in February 2021 (based on current vintage data).

The regional breakdown of the PAYE measure shows falls in all 12 regions, with the largest (1.0%) in London – also consistent with the Report on Jobs, which reported that permanent placements weakness was led by London.

As the chart shows, the PAYE employees measure correlates with the quarterly employee jobs series, which has “official” status but is less timely – an end-Q1 number will be released next month. (This series, like US payrolls, counts positions rather than people.)

Chart 1 showing UK Employee Jobs, Payrolled Employees & Vacancies *Single Month, Own Seasonal Adjustment

The Labour Force Survey employment measure rose by 182,000 in the three months to March from the previous three months but self-employment and part-time employees accounted for the increase – the number of full-time employees fell.

A post last week suggested that employment would begin a sustained decline in Q2, based on recent weakness in vacancies. The official vacancies series – a three-month moving average – fell again in April. The single-month number calculated here is now down 20% from peak (April 2022), with the month-on-month decline accelerating last month. (The FT incorrectly reported that vacancies stabilised in April.)

Another labour market report is due before the MPC’s next meeting on 22 June. Confirmation that employment is on a falling trend would transform the policy debate.

*The revision to the month-on-month change reflected a downgrade to the level of employment in February, not an upgrade to March.

UK vacancies – like US job openings – are signalling an employment recession.

A previous post noted that a fall in US job openings of more than 15% from a rolling 12-month high was always (since the 1950s) associated with a multi-month fall in payrolls. The 15% threshold was crossed in February data released last month, with the shortfall increasing to 18% in March.

It turns out that the 15% rule also works in the UK, correctly signalling all eight employment recessions since the 1960s with no false warnings. Recent developments mirror the US: the decline in vacancies from peak crossed 15% in January, rising to 17% in March.

The official vacancies series, based on a survey of employers, starts in 2001. Earlier numbers are available (back to 1960) for vacancies notified to Jobcentres. When the latter series was replaced in 2001, Jobcentre vacancies accounted for about 60% of the total. The analysis here combines the two series, effectively assuming that Jobcentre vacancies were a constant proportion of the total before 2001.

Employment recessions were defined as multi-quarter declines in an average of two series – total employment (from the Labour Force Survey of households) and workforce jobs (based mainly on a survey of employers). The latter series – like US non-farm payrolls – counts positions rather than workers and is about 10% larger, reflecting multiple job holding.

As in the US, the 15% threshold was usually reached around the time that employment started to decline, although this may not have been immediately apparent because of reporting lags and revisions.

A Q1 reading of the total employment series is not yet available but LFS data through February and PAYE employee numbers suggest another rise. Based on the vacancies signal, a sustained decline may begin in Q2.

US February job openings were 17% below their March 2022 peak. Historically, a decline of this magnitude in vacancies – job openings or, for earlier years, help-wanted advertising – was always associated with a payrolls recession.

Job openings numbers are available back to 2000. Regis Barnichon, now at the San Francisco Fed, constructed a proxy series – composite help-wanted advertising – for earlier decades. The Barnichon series adjusts historical data on newspaper advertising for a rising share of online job postings, modelled by an S-curve.

The official and Barnichon series (which is no longer updated) can be spliced together to create a continuous vacancies series extending back to the early 1950s, a period encompassing 11 recessions involving sustained payrolls declines – see chart 1.

Chart 1

Every payrolls decline was preceded by a fall in vacancies but several vacancies declines were followed by slowdowns in payrolls rather than outright weakness (e.g. 1966).

A sufficient condition for a payrolls recession was a fall of more than 15% in vacancies from their peak level in the latest 12 months – chart 2. This condition was met in February job openings numbers released last week.

Chart 2

Historically, the 15% threshold was reached around the time that payrolls started to decline. In six of the 11 cases, payrolls had already peaked, although this was not always known at the time.

As an example, current data show a 1974 payrolls decline beginning in August, one month before the vacancies fall reached the 15% trigger. In real-time data, however, a payrolls peak was delayed until October.

The unusually high level of job openings may be affecting the seasonality of US labour market data. An accurate read on the non-seasonal employment trend may not be possible until the spring.

The normal seasonality of US private payrolls is captured by the difference between BLS unadjusted and seasonally adjusted stock series, shown in chart 1. The seasonal effect is roughly neutral in September, rises to a peak in November, turns substantially negative in January and recovers back to neutral in May.

Chart 1

The normal pattern of employers shedding jobs on a large scale in January but rehiring into the spring / summer could change when the labour market is unusually tight, as currently. Firms may prefer to hold onto workers as seasonal activity slackens, anticipating difficulties refilling jobs later in the year. Laid-off employees may find alternative work more rapidly than in a normal year.

A change of behaviour may explain the blockbuster January payrolls rise, i.e. the seasonal adjustment may have significantly overestimated the seasonal drop in employment this year.

An alternative approach to assessing the underlying jobs trend is to compare months when the seasonal effect is neutral. As noted, September and May are neutral months, while seasonal deviations are significant over October-April. The average change in unadjusted payrolls over September-May should be an undistorted measure of employment growth.

If the suggestion of a seasonal distortion is correct, headline payrolls growth numbers for February-May could understate the underlying trend, compensating for January’s (possible) overstatement.

Suppose, for illustration, that monthly growth in unadjusted payrolls turns out to average 150,000 between the two seasonally neutral months of September 2022 and May 2023. (This equates to an annualised growth rate of 1.4%, in line with the reported expansion of the labour force in the year to January, i.e. the assumption is consistent with a stable unemployment rate.)

Such growth would imply a payrolls level of 132,686,000 in May 2023, with no significant seasonal element. This compares with a currently reported seasonally adjusted level of 132,684,000 for January. The headline payrolls measure, on these assumptions, would show negligible growth over February-May.

The consensus is gloomy about UK economic prospects but is it gloomy enough?

The current debate has echoes of mid-2008. Q2 2008 was the first quarter of the most severe post-war recession. The consensus that summer was that the economy would eke out growth with a limited rise in unemployment and no need for significant policy easing.

A recession is widely acknowledged / expected now but the majority view is that it will be shallow and short-lived, partly reflecting recent energy price relief. Labour market damage is projected to be modest and there is general approval of recent MPC policy tightening.

Monetary trends warned of worse-than-expected outcomes in 2008 and are giving an equally negative message now.

The six-month rate of contraction of real narrow money (i.e. non-financial M1 deflated by consumer prices) was unchanged at 5.9% (not annualised) in December, close to a 6.1% peak reached in October 2008 – see chart 1.

Chart 1

As in 2008, the real money squeeze reflects both high inflation and nominal money weakness. Sectoral nominal money trends are uncannily similar to mid-2008. Corporate M1 and M4 are contracting rapidly, consistent with a sharp fall in profits and suggesting cuts in employment and investment – chart 2.

Chart 2

Household M4 is still growing modestly but there has been a large-scale switch out of sight into time deposits in response to rising rates – a classic signal of a shift in consumer behaviour from spending to saving.

A continued rise in employee numbers in recent months has fed a narrative of labour market “resilience” that is expected to persist. Data and complacency were similar in mid-2008. The quarterly employee jobs series rose into Q3 2008 but the stock of vacancies in June was already down by 9% from its peak, warning of trouble ahead – chart 3. The level of vacancies is higher now but the fall from the peak has been larger, at 14%.

Chart 3