Following last year's shift from shortages to gluts in the global market for goods, we are now seeing signs of a shift from shortages to gluts in the global market for labor. But, will the pace be fast enough to bring down core inflation materially by year-end and provide relief to central bankers?

At the height of the supply chain shortages in early November 2021, we warned of a likely rapid move from supply shortages to gluts of goods and materials by the second half of 2022.

"In the past, the markets seem to have moved suddenly from a shortage to a glut. After a year of supply shortages, we may be closer to the end of the supply chain problems than the beginning. As a leading economic indicator, markets tend to look six-to-12 months ahead; they may soon begin to consider the possibility that some shortages may have started to ease, and gluts may have started to form by the second half of next year."

Sure enough, by the middle of 2022 gluts of inventory had formed at retailers and manufacturers around the world. The inventory-to-sales ratio at general merchandise retailers in the U.S. soared to the levels that had not been exceeded since the failure of Lehman Brothers in the fall of 2008, according to company sources. The Purchasing Managers' Index (PMI) survey of manufacturers' inventory levels in Europe reached a record high according to PMI data by S&P Global. Companies ranging from Walmart to Nike warned about the need to cut excessive inventories as they reported second quarter 2022 earnings.

The change from shortages to gluts in the global market for goods that took place in mid-2022 may now be shifting to the global labor market of 2023. Company communications on earnings calls and shareholder presentations reveal a rising trend of mentions of job cuts (including phrases like "reduction in force," "layoffs," "headcount reduction," "employees furloughed," "downsizing," and "personnel reductions") along with a falling trend in mentions of labor shortages (including phrases like "labor shortages," "inability to hire," "difficulty in hiring," "struggling to fill positions," and "driver shortages").

Lending conditions are also contributing to the weaker jobs outlook. There is a clear and intuitive leading relationship between banks' lending standards and job growth. The magnitude of the recent tightening in lending standards from banks in the U.S. and Europe points to a shift from job growth to job contraction in the coming quarters.

One reason why jobs growth has been so resilient over the past year despite global economic weakness is the unique nature of the global economic environment: Manufacturing is in recession while services are growing in response to the post-pandemic surge. The gap between the services and manufacturing Purchasing Managers' Indices is the widest ever.

Services are more labor-intensive and employ more people than manufacturing, which tends to be more capital-intensive. For example, in the U.S. private sector there are 112 million services jobs in comparison to 13 million manufacturing jobs, a ratio of about 9-to-1, as of April 2023. In the European Union, the ratio is lower, at about 4-to-1, but still overwhelmingly tilted towards services, per Eurostat data.

The record-wide gap between growth in services and weakness in manufacturing suggests an imbalance that may need to readjust. It may be the strength in the services economy—and therefore jobs—if the lagged impact of bank tightening begins to have more of an impact.

A weaker job picture may help central banks, who have voiced concerns about tight labor markets and strong wage growth sustaining inflation pressures. A weakening job outlook may allow central bankers to eventually move toward a more dovish stance, which might boost stocks. However, the shift from shortages to gluts in the labor market may not be fast enough to bring down core inflation materially by year-end to allow central banks the freedom to declare victory over the drivers of inflation and begin to cut rates aggressively.  

Michelle Gibley, CFA^®, Director of International Research, and Heather O'Leary, Senior Global Investment Research Analyst, contributed to this report.