Jobs-friendly Fed soft landing hinges on history not repeating

September 2 (Reuters) – Federal Reserve officials have acknowledged that the battle against inflation will be paid for in job losses, and the U.S. central bank will need an unlikely combination of events to keep those losses going. minimum as interest rates continue to rise.

Economists assessing the trade-off facing the Fed believe that employment in the United States could fall from a few hundred thousand jobs to several million before the Fed corrects the worst inflation spike in 40 years.

The final tally will depend on how well the economy follows the patterns seen over the past few decades, how well things like improving global supply chains help lower inflation, and how much the Fed is strict in applying its 2% inflation target.

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With the central bank’s preferred measure of inflation currently rising at an annual rate above 6%, Joe Brusuelas, chief economist at RSM, a US-based consulting firm, estimates it would take 5.3 million jobs lost and an unemployment rate of 6.7%, significantly above the 3.7% observed in August, to bring inflation down to 2%.

“Can the Fed pull off a pure soft landing? … Probably not,” Brusuelas said, referring to a scenario in which monetary tightening slows the economy and slows inflation, without triggering a recession. “It’s hard to envision a benign result.”

August jobs data, released on Friday, gave the Fed some breathing room. US businesses added 315,000 jobs in August, a slowdown from the explosion of half a million jobs added in July and a sign that some of the economy’s post-pandemic excesses may be moderating unabated completely.

In addition, the number of people in the labor force jumped nearly 800,000 to a new record high — a momentum that Fed officials have been banking on to ease wage pressures over time. Because many of these new entrants had yet to find jobs, the unemployment rate rose from 3.5% to 3.7%, an increase that the Fed and other officials will likely view as constructive because it indicates a greater supply of people willing to accept a job if offered.

“I don’t mind seeing a slight uptick in unemployment if we get more people into the job market. It’s good for business,” said U.S. Labor Secretary Marty Walsh. “We still hear concerns” from businesses about difficulties in hiring workers, “but not as loudly,” he said. .

Fed officials hope the burden of fighting inflation falls less on jobs than on other sectors of the economy, even though for months they have lamented the current state of the labor market as unsustainable.

The August jobs report did not allay all these concerns. Average hourly earnings continued to increase at a year-over-year pace of 5.2%, similar to the previous month.

Fed officials believe that needs to slow, with Cleveland Fed Chair Loretta Mester saying this week that she estimates wage growth “should moderate to around 3.25% to 3.5% for be compatible with price stability”.

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Fed officials have been less specific about what will balance things out, with some of the labor ideas requiring U.S. labor markets to act differently than they have in the past.

Fed Governor Christopher Waller pointed to the Beveridge curve, which plots the relationship between job vacancies and the unemployment rate, to argue that the labor market may behave differently this time.

The current ratio of two job offers for every unemployed person is a record. Typically, when the vacancy rate decreases, the unemployment rate increases because it becomes more difficult for job seekers to find a match. But Waller argues that the Beveridge curve has shifted during the pandemic and is now in a place that would allow job vacancies to fall sharply as the economy slows, easing pressure on wages and prices, without much unemployment increase.

“We recognize that it would be unprecedented for job vacancies to drop significantly without the economy falling into recession… We are saying, in effect, that something unprecedented can happen because the labor market is in a an unprecedented situation,” Waller wrote. in a research note published by the Fed in late July.

Other soft landing stories also depend on history not repeating itself.

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In June, for example, the median estimate from Fed officials was that unemployment would rise somewhat — but only to about 4.1% by the end of 2024, a slow and limited increase.

Updated projections are expected to be released at the end of the Fed’s monetary policy meeting on September 20-21. If, as expected, these projections show higher unemployment, the chances of a soft landing will be up against an unpleasant historical fact: once the US unemployment rate exceeds a certain amount, it tends to continue to rise.

Since at least the late 1940s, even modest increases of half a percentage point in the unemployment rate from a year earlier — the size of the increase that Fed officials began to talk about – tended to climb at jumps of 2 percentage points or more.

At the current labor force level of 164.7 million, this would translate to around 3.3 million fewer people employed – below some estimates but still high.

“Usually once the labor market gets worse, it gets faster and it gets worse,” said Claudia Sahm, a former Fed economist and founder of Sahm Consulting.

As a Fed economist, she developed the eponymous “Sahm ​​rule,” which says that once the three-month average unemployment rate rises half a percentage point from its recent low, the economy is already in recession. Given the quirks of the pandemic-era job market, however, she’s open to an exception this time.

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Sahm’s baseline is for an increase in the unemployment rate to around 4%, which would translate into a loss of less than a million jobs, but for the economy to avoid a recession.

It would take a lot of things to get that result.

The August jobs report shows how this could work: higher unemployment thanks to more people joining the labor force rather than the strings of layoffs seen during a recession.

The best outcome for the Fed “depends on supply chains healing, more people getting back into the workforce, more price sensitivity among consumers,” Sahm said. “It’s a normalization of the economy.”

If that doesn’t happen and labor market pain increases, the Fed would have options, including raising the inflation target from the current 2%. Brusuelas estimates that hitting a 3% inflation rate would cost 3.6 million fewer jobs than insisting on hitting the current target, with the unemployment rate rising by just over a percentage point compared to the current level.

So far, that’s not a conversation the Fed wants to have.

“We have communicated over and over again our commitment to achieving that 2% target,” New York Fed President John Williams told The Wall Street Journal this week. “I think it will take a few years, but there is no confusion… We are absolutely determined to do this.”

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Reporting by Howard Schneider; Editing by Dan Burns, Paul Simao and Andrea Ricci

Our standards: The Thomson Reuters Trust Principles.

howard schneider

Thomson Reuters

Covers the US Federal Reserve, monetary policy and economics, graduated from the University of Maryland and Johns Hopkins University with previous experience as a foreign correspondent, business reporter and local Washington Post staffer.

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