By Jeanna Smialek
An object in motion stays in motion. Is a labor market trend that’s well underway any different?
That’s the question looming for officials at the Federal Reserve as they try to pull off a feat that has never really been accomplished before: gently cooling an economy that was experiencing rip-roaring inflation without tanking the job market in the process.
So far, the Fed’s attempt at a soft landing has worked out better than just about anyone, including central bankers themselves, expected. Inflation has cooled significantly, with the consumer price index down to 2.5% from a peak of 9.1% just two years ago. And even with the Fed’s policy interest rate at its highest level in more than two decades, consumer spending has held up and overall growth has continued to chug along.
Fed officials are eager to keep it going. That is why all signals suggest that they will lower interest rates at the conclusion of their meeting Wednesday — and the only real question is whether they will cut them by a typical quarter of a percentage point or by a half percentage point. They are also likely to forecast that they will lower interest rates further before the end of the year, perhaps predicting that they will cut them by a full point from their current 5.33%.
But even as the Fed turns an important corner on its fight against inflation, real risks remain. And those center on the labor market.
Unemployment has been slowly, but steadily, rising. Wage growth has been consistently slowing. Job openings have come down, and hiring rates have come down along with them. And while all of those developments are what the Fed wanted — the point of this exercise was to slow an overheated job market and prevent it from fueling future inflation — central bankers have been clear that they do not want to see it continue.
“We do not seek or welcome further cooling in labor market conditions,” Fed Chair Jerome Powell said in his latest speech.
The problem is that it is not obvious what, exactly, will cause the deceleration that is clearly happening in the labor market to suddenly stop. Fed rate cuts should help by cheering up businesses and padding demand, but central bank policy changes work like slow-release medicine. They do not change the whole economy overnight.
That is why some onlookers are beginning to worry that the Fed might fall behind the curve if it reacts too gradually — something that would leave it scrambling to lower borrowing costs quickly enough to keep the job market from falling to pieces.
“Not all slowdowns lead to recessions, but all recessions start with slowdowns,” said Skanda Amarnath, executive director at Employ America, an employment-focused research and advocacy group. “I think the data is signaling a certain amount of urgency.”
The Fed has been approaching rate cuts cautiously because it does not want to risk taking its foot off the economic brakes too early or too swiftly, allowing the economy to heat back up and making it harder to fully stamp out inflation.
But caution on the inflation front could translate into risk-taking on the employment front.
The first and most concerning sign of labor market deterioration has been the recent rise in joblessness. After dropping to 3.4% in 2023, unemployment had risen to 4.2% as of August. That happened both as people left jobs and as new people entering the labor market took time to find open positions.
The question is whether the upcoming shift in Fed policy will be enough to cause that slow but steady increase in joblessness to halt abruptly. While it paused in August, the slow move up has in general been playing out since last summer.
The same question applies to wage growth, which is a signal of how hard companies are competing to hire. If the job market is roaring and employees are hard to come by, businesses tend to pay up to lure them away from the competition or to retain their existing employees. If the job market is softening, pay growth slows.
That’s what’s happening now. Average hourly earnings for rank-and-file workers have gone from a peak 2022 growth rate of 7% to a more muted 4%. That’s still faster than just before the pandemic, but just a touch: Wage growth was about 3.7% in the summer of 2019.
And a noteworthy change is happening in job openings. They have marched steadily lower, and are back where they were on the eve of the pandemic. That’s relevant because unemployment historically climbs as job openings decline, a relationship that economists often refer to as the “Beveridge Curve.”
In fact, Dallas Fed research this year predicted that joblessness might rise, warning that “the decline in job vacancies without a corresponding increase in unemployment may not last.”
But even as signs of a softening labor market accumulate, Fed officials have explained that there are reasons to hope that this time could be different.
Past Fed efforts to cool inflation by slowing the labor market have resulted in painful recessions: The clearest example of that is the back-to-back downturns that plagued the country during the early 1980s.
And past economic relationships would suggest that with unemployment rising the way it has recently, an economic downturn is likely. Usually, higher joblessness heralds recession, as unemployed people and jittery workers pull back on consumption.
But this time, the pandemic has rattled the economy so much that economists think it is possible that what is happening is a gradual reversion to normal, rather than a painful crunch.
“It should be clear to everyone that many prepandemic economic relationships have not proven to be good policy guides postpandemic,” Christopher J. Waller, a Fed governor, said in a recent speech. “While I don’t see the recent data pointing to a recession, I do see some downside risk to employment that I will be watching closely.”
For instance, Fed officials often note that part of the recent increase in unemployment has come from a wave of new entrants into the labor market, not from a spike in layoffs. While layoffs are gently rising, they have not jumped sharply.
That is why some economists are still hoping for the soft landing — especially if the Fed acts in time.
Fed officials are considering a bigger rate decrease this month specifically because they are alert to the job market risks. And even if they do not make a big cut, they are likely to signal that more rate moves are coming, and that a large rate cut at their next meeting is possible if data warrants it.
“If employment weakens from here, they are going to have to — at some point — do a half-point cut,” said Diane Swonk, chief economist at KPMG. “The bottom line is that the Fed, Powell, clearly wants to nail the soft landing. This is his legacy.”
Comentários