asset allocation  |  may 23, 2023

U.S. Labor Market Strength May Be Tenuous

Emerging signs of weakness could be headwinds for jobs.


Employment is a key recession indicator. In the first and second quarters of 2022, real GDP growth was negative. While two consecutive quarters of negative GDP growth would typically constitute a recession, this period was not officially considered a recession primarily because employment did not weaken.

In fact, employment actually improved during both quarters with the unemployment rate falling from 3.9% as of December 2021 to 3.6% as of June 2022. And despite further economic softness over the past year, the unemployment rate has improved further and remains at a remarkably low level of 3.5% as of March 2023.

On top of this low unemployment rate, there are also almost 10 million unfilled job openings in the U.S. economy based on the March 2023 jobs report. Which means there are approximately 1.7 job openings for every single unemployed worker, a historically strong level for the labor market.

However, there are reasons to be concerned that the strength of the labor market could rapidly evaporate over the next 12 months.

Small Business

One reason to be concerned is the role that small businesses play in the employment market.

Small businesses account for a very large share of U.S. employment. According to the U.S. Department of Labor statistics as of March 2022, businesses with less than 250 employees accounted for 73% of all jobs in the U.S.

The reason this is concerning is because small businesses rely heavily on banks for their ongoing credit needs. This means that when banks become more cautious about offering loans to business clients, small business activity usually suffers and consequently the job market tends to weaken. We can illustrate this relationship by comparing historical data on bank lending standards to data on job losses over the subsequent 12 months.

Given that bank lending standards have already tightened considerably, a sharp increase in job losses could potentially be on the horizon. In fact, economic survey data tell us that hiring intentions at small businesses are already weakening, albeit from a very strong level.

Corporate Profit Margins

Another reason for concern is that corporate profit margins are falling. When input costs spiked in 2021 and 2022, corporations were initially able to pass these higher costs on to consumers in the form of higher prices. But consumers have become much less willing to pay higher prices as their savings balances have dwindled.

As a result, corporate profit margins have begun to come under pressure—and while they remain at relatively healthy levels in aggregate, those businesses that already had narrow margins are beginning to see profit margins go negative.

Unfortunately, falling profit margins are almost always bad news for employment, as once employers begin losing money they are inevitably forced to cut costs by laying off employees.

Negative Momentum Is Hard to Reverse

The good news is that we are still in the very early stages of the employment market weakening. In fact, a modest amount of weakness in employment could help push wage inflation back to sustainable levels, which is exactly what the Fed is trying to achieve by raising interest rates.

Unfortunately, history tells us that weakening employment a little, but not a lot, is very difficult to achieve. This was famously captured by former Fed economist Claudia Sahm, who observed that whenever the three-month moving average of the national unemployment rate has risen by 0.5 percentage points above its prior 12-month low, a recession has occurred. More simply put, once unemployment gains momentum, it is very hard to reverse.


In conclusion, the apparent strength of the U.S. employment market may be more tenuous than it appears. Forward-looking indicators are showing early signs of weakness, and history tells us that once employment momentum turns negative, it is hard to stop.

As a result, we remain cautious about the medium-term path for the U.S. economy and will be keeping a close eye on forward-looking employment indicators.


Key Insights

  • The U.S. labor market faces headwinds amid tighter credit conditions for small businesses and declining corporate profit margins.

  • We are closely monitoring forward-looking employment indicators, as historical data show that a persistent uptick in unemployment can be difficult to reverse.

The current strength in the U.S. labor market could deteriorate over the next 12 months. Tighter bank lending standards typically hurt small businesses—which account for a very large share of the U.S. employment market—and falling profit margins usually mean bad news for jobs.

In the first half of 2022, strong employment data helped to fend off a U.S. recession despite negative gross domestic product growth in the first and second quarters. While the economy has further softened over the past year, the labor market remains at a historically strong level, with unemployment at a remarkably low rate of 3.5% as of March 2023. However, emerging signs of weakness could mean that job losses are on the horizon.

Following the recent banking woes, risk-conscious banks have been tightening lending standards to help preserve liquidity. Since small businesses often rely heavily on banks for their ongoing credit needs, tighter credit conditions could limit their operations, which would not augur well for the labor market (Figure 1). In fact, current survey data show that small businesses have moderated their hiring intentions.

Tight Credit Conditions Often Weaken Labor Market

(Fig. 1) Job losses versus tighter bank lending standards

Tight Credit Conditions Often Weaken Labor Market Line Graph

January 1, 1991, through March 31, 2023.
Past results are not a reliable indicator of future results.
Source: Bloomberg Finance L.P.

Falling corporate profit margins are another concern for the labor market. With dwindling savings, consumers have become less willing to pay the higher prices that corporations charged post-pandemic to help offset surging input costs. As corporate profits decline, employers may inevitably be forced to cut costs by laying off employees (Figure 2).

Modest weakness in the labor market could help to push wage inflation back to sustainable levels, which would be positive for the economy. However, historical data show that once employment momentum turns negative, the trend is very difficult to reverse. Therefore, we are closely monitoring forward-looking employment indicators, and we remain cautious about the medium-term path for the U.S. economy.

Falling Profit Margins Typically Lead to Job Losses

(Fig. 2) Profit margins versus weekly job losses

Falling Profit Margins Typically Lead to Job Losses Line Graph

January 1, 1998, through March 31, 2023.
Past performance is not a reliable indicator of future performance.
Sources: U.S. Bureau of Labor Statistics and the Federal Reserve Bank of Atlanta/Haver Analytics.

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Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of May 2023 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

T. Rowe Price cautions that economic estimates and forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual outcomes could differ materially from those anticipated in estimates and forward-looking statements, and future results could differ materially from historical performance. The information presented herein is shown for illustrative, informational purposes only. Forecasts are based on subjective estimates about market environments that may never occur. Any historical data used as a basis for this analysis are based on information gathered by T. Rowe Price and from third-party sources and have not been independently verified. Forward-looking statements speak only as of the date they are made, and T. Rowe Price assumes no duty to and does not undertake to update forward-looking statements.

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