The Fed Panicked When The Job Market Had Already Cooled; Here's The Proof

The Fed may have caused more harm than good by trying to slow down the job market.

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May 14, 2023 • 4 min read

Investors may be wondering if the Federal Reserve has overdone its tightening monetary policy due to currency crashes, rising Treasury yields and the new bear-market low of the S&P 500. There's now more reason to wonder if the Fed erred by releasing so much force in order to stop a runaway jobs market while it battles inflation. The Treasury Department's latest tax data suggests that the Fed may have underestimated the strength of the job market.

IBD's analysis of the daily Treasury statements reveals that, in the four-week period ending Sept. 23, federal income and employment tax withheld totaled just $224.46 Billion. This is a 2.7% increase from a year earlier. This is a shockingly low rate of growth, considering Labor Department data that shows wages are up more than 5% from the year before and an increase of 5,8 million jobs.

In the last 10 weeks, taxes withheld have increased by a respectable 4.5% compared to a year earlier. The Commerce Department's July data is the most recent available. But it still falls short of the 10% reported growth rate in total wages and salaries. Labor Department data also shows that aggregate wage income rose 9.4% in August compared to a year earlier.

This suggests that the reported income may be overstated. This means that consumers may have less purchasing power than they think. Tax data appears to confirm other statistical evidence that casts doubt on the strength and stability of the job market.

It's not a fair comparison to compare the rate of growth in tax withholdings versus aggregate wages. Taxes also cover incentive payments, and not all income from labor is taxed the same.

It's not surprising to a certain extent that wage growth this year has lagged behind the rate of growth in tax withholdings. This is because the 2021 tax data has been inflated by bonuses and stock options exercised near the peak of an historic bull market.

Mark Booth, in his Tax Tracking Blog, noted that a shift of income gains to workers who pay marginal tax rates lower than the average may also be limiting the growth of tax revenues.

This means that the slow increase in tax withholdings this year compared to levels in 2021 does not, on its own, prove that job growth has been overstated.

Federal Reserve Expects Key Rate To Peak At 4.6%

A comparison with tax data from 2019 confirms that the job and income gains this year aren't quite as large as reported. The reported wage and employment growth in 2019 is far greater than the trend of 3% wage growth and 120,000 jobs added each month from late spring until early fall. The Commerce Department's data shows that this strength is reflected by an acceleration in wage income for 2019 compared to 2018. It went from a 20% increase in March to a 23% growth in July.

If the job growth this year was as strong and reported, then tax withholdings should also be increasing compared to 2019. They don't. Instead, they hold at around 20%. In fact, the rate has actually slowed over the last five weeks.

According to the headline figures of the monthly employment report, derived from an employer survey conducted at the mid-month, the U.S. has created 1.9 million new jobs in the last five months. The household survey, which is used to calculate the unemployment rate, shows that the number of workers has only increased by 274,000 since march. The number of full-time workers has decreased by 383,000 in the same time period.

Why could government job reports exaggerate the growth of employment? One possible reason is an inaccurate seasonal adjustment. Take August's jobs report. The government data shows that the private sector added 308,000 jobs when adjusted for seasonality but only 57,000 unadjusted. It's strange that the 251,000 increase from the seasonal adjustment is nearly 200,000 higher than it was in 2018 or 2019

In the last five months, seasonal adjustments factors have added 364,000 jobs to the private sector compared with the average adjustment for 2018, 2019, and 2021.

The adjustment for new companies and the death of non-viable firms could also be off. Over the last two months, the adjustment has increased the number of jobs by 418,000. This is 110,000 more jobs than the average birth/death adjustments over the same time period in 2018, 2019, and 2021.

The adjustment for births and deaths reflects a lot of past trends. Labor Department statisticians do not attempt to account for current economic conditions. The current economic conditions are not ideal. Interest rates are surging during the Fed's most aggressive tightening cycle in the 1980s.

The Bank of England's Wednesday reversal, in which it said that it would purchase bonds at "whatever level is necessary" to ease financial market disruptions, helped spark a rally on the stock market for one day.

The move shows how aggressive Federal Reserve tightening put other central banks worldwide under immense pressure. The Fed may have to change its approach in order to provide real relief. The best news for the short term is an unexpectedly weak September jobs report due on October 7. This could indicate that the Fed will need to take a less drastic approach and lower interest rates in order to rebalance its job market.

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