by the Asset Allocation Committee | PDF

Since the Federal Reserve was granted independence in 1951 there have been 11 recessions.  Although each recession and recovery are somewhat unique, analysts tend to compare them for clues about future economic activity and policy actions.  In terms of monetary policy, Chair Powell has staked out a dovish path, suggesting that the first rate hike may not occur until 2023.  However, recent comments from Fed officials suggest the chair’s position is becoming increasingly isolated.

On this table, voters are designated by stars.  Currently, there are five committed doves on the FOMC.  We expect the no-bias camp to vote for stimulus reduction next year at the earliest.  The hawks, on the other hand, are committed to moving this year.  Although we could see a rise in dissents later this year, we suspect that policy will remain steady until 2022.

Next year could be interesting, to say the least.  Powell’s term as chair ends in February and Quarles’s term as vice chair for regulation ends in October 2021.  His full term as governor extends to 2032; although it is customary for a governor to step down once a vice chair position ends, Quarles has indicated he will stay around for a while.  If the no-bias group shifts to tightening, Powell may have to tighten or face losing a vote.

Monetary policy in recoveries and expansions has varied over the years.  Prior to 1982, it wasn’t always clear from the behavior of fed funds alone whether policy had changed.  To estimate changes, we can also use the New York FRB discount rate as an indicator.

Looking at the recessions from 1955 (the first after independence) onward, what is striking is that the FOMC often moved to raise rates rather quickly after the recession ended.  During the seven recessions, the average number of months from the end of the recession to the first rate hike is 13 months.  In the past three, the average is 48 months.  It has been four decades since the FOMC raised rates quickly into a recovery.  For three decades, investors have become accustomed to the slow withdrawal of stimulus.

However, this recovery appears to be much different than the past three.  In part, the recovery has been stronger due to massive fiscal and monetary policy support.  But another factor is that the recession, although short in duration, was unusually deep.  Although sometimes deep recessions have “L”-shaped recoveries, this one did not.  One way to see this is by comparing job openings to the number of unemployed workers.

During the entirety of the recovery from the 2001 recession, the number of unemployed exceeded job openings.  In the previous recovery, it took until March 2018, almost nine years after the recession ended, for openings to exceed the number of unemployed.  In the current recovery, we crossed that line in May, 13 months after the last recession ended.

Unfortunately, the JOLTS report, which measures job openings, started in 2000, so it doesn’t provide a long-term history.  The Conference Board had a series where it measured help wanted ads relative to the number of unemployed.  It was discontinued in 2010.  Although that number is a ratio based on an index, we created a model from the JOLTS report that approximates the help wanted/unemployed ratio to the present.

Comparing the behavior of the help wanted/unemployed ratio from the end of every recession since Fed independence, the current recovery is acting more like the pre-1990 cycles.  We have denoted the past three with dots on their lines and it is notable that the labor market didn’t improve over the two years after the end of the recessions.  So far, the FOMC leadership is acting as if this recovery is similar to the past three cycles; if it is not, policy will likely need to tighten much faster than the market expects.

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by the Asset Allocation Committee | PDF

In analyzing the path for the economy, an important factor is separating the temporary effects of the pandemic from those that are longer lasting.  The debate over whether inflation will be transitory is tied to this determination.  The impact on the labor markets is another element.  One change that appears to be permanent is that the pandemic accelerated retirement among baby boomers.

Currently, Americans born in 1959 or earlier are eligible for Social Security, but 65 years old remains the traditional retirement age.  Americans working past 65 years old, at least as a percentage of the total labor force, was common after WWII.  Social Security was still relatively new.  However, from 1947 to 1985, the participation rate for Americans over the age of 65 fell from the 28.6% peak in October 1949 to a low of 10.4% in June 1984.  The number of Americans in the labor force over the age of 65 peaked at 11.2 million in February 2020.  It has fallen since the onset of the pandemic.  The participation rate, the percentage of workers relative to the labor force, has declined since the onset of the pandemic and is continuing to decline.

The chart above shows both the actual number of civilians employed over the age of 65 and the percentage of these workers compared to the labor force of 65-year-olds and older.  Participation has been rising since the early 1990s.  Some of this rise is simply due to a rising population of Americans aged 65 years and older relative to the total population.

This chart shows the actual and projected level of 65-year-olds and older compared to the total population.  The percentage has been rising since 2003 and is forecast to plateau in 2040.  The entire baby boom generation will be 65 years or older by the end of the decade.

We developed a simple model to measure labor participation of those 65 years and older compared to the population of that age cohort.  Starting in 2008, the model generally predicted the path of participation in this age bracket.  However, since the pandemic, participation has plunged, and the pattern suggests that it’s likely permanent.  Using a similar calculation using the employment/population ratio for this age cohort, the decline in older worker employment represents around 833,000 jobs.  Assuming a stable labor force, that would have reduced the overall unemployment rate to 4.9%.

What impact would a decline in workers aged 65 and older have?  Since older workers are often paid more due to their years of service, losing these workers will, at least initially, improve margins.  It will almost certainly lead to some increased hiring of younger workers and may accelerate lowering the age of the workforce.  Industries will not be equally affected; some are at high risk.  For example, in 2020, 32.9% of farmers and 25.0% of aircraft assemblers are in this age bracket.

For markets, older Americans who leave the workforce may be inclined to reduce their equity positions.  However, returns in fixed income are paltry, so the potential negative impact might be less than one would expect.  Dividend-paying equities could be particularly attractive.  But overall, the impact on financial markets will likely be centered on the wage effects.

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