Continued tightening of the U.S. labor market

Labor market continues to tighten

August unemployment came in at an incredibly low rate of 3.7% and saw the U.S. economy add 315,000 jobs. This number signals a continued tightening of the labor market as unemployment rates have remained below 5% since August of last year. It also suggests that despite inflation running hot, most consumers at least have an income source they can rely on to weather the conditions.

It’s also worth mentioning that while unemployment peaked at 14.8% in the depths of the pandemic, it has returned steadily over time, now reaching pre-pandemic levels.

Implications – more negative than positive

On the surface, a strong labor market should be viewed as a positive thing. More employed individuals lead to greater consumer spending, which improves business profits leading to more growth and hiring activity. In effect, a virtuous cycle. However, with the current environment dominated by inflation fears, tightened labor conditions may not be as positive as many would expect.

With inflation top of mind, low unemployment figures serve to only make matters worse as continued labor shortages are contributing to supply chain issues and ongoing inflationary pressures. Furthermore, the tighter the labor market gets, the greater wage pressure there is as businesses need to pay more to attract workers – this also leads to an increase in inflation.

With inflation running so hot, the Federal Reserve has been forced to take action in the form of aggressive increases in interest rates. However as rising rates generally result in reduced demand and a slowdown in capital markets activity – key factors in contributing to a potential recession – the market is understandably fearful of a policy mistake. The Federal Reserve must increase rates to quell inflation expectations, which is their primary mandate, yet raising interest rates too quickly and too aggressively will send the economy into a recession. And the tightening labor market increases the likelihood that the Fed will continue to make larger rate hikes.

ETFs to consider in a tight labor market

An effective way for investors to position their portfolios given a tightened labor market includes equities that can pass through inflation to their customers. This includes companies within the Consumer Staples and Healthcare sectors (which both have performed relatively better than other sectors thus far this year, although still negative commensurate with the broad market sell-off). 

ETFs to consider include IXJ (iShares Global Healthcare Index ETF), IYH (iShares U.S. Healthcare ETF), and PTH(Invesco DWA Healthcare Momentum ETF).

And within the Consumer Staples space, XLP (Consumer Staples Select Sector SPDR Fund), IYK (iShares U.S. Consumer Staples ETF), and VDC (Vanguard Consumer Staples ETF) could be worth watching.

Data for this article is as of September 1, 2022.

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