Lights on the runway for the soft landing
The Fed faces tough decisions, geopolitics and commodity markets are a wild card, and it's an election year. There's a lot that could go wrong, thankfully, we have help in landing the plane softly.
2023 was the impossible becoming reality—a big decrease in inflation with unemployment staying very low. Now, in 2024, we are aiming at the impossible twice over: the soft landing. It won’t be easy.
We can see the runway, and even if the Fed makes some mistakes on the way down, we can land the plane. That’s the case I made in my recent Bloomberg Opinion piece.
The labor market is strong.
The American consumer keeps going.
Most Americans are better off financially.
Inflation is moving quickly toward 2%.
Recession fears are fading.
Jobs! Jobs! Jobs!
The linchpin of the soft landing is the ongoing strength in the labor market, and my piece goes through the argument in detail.
Last Friday, we learned that we closed out 2023 with unemployment below 4% for its longest stretch since the 1960s, and we added 2.7 million jobs. And many of these are good jobs. The number of workers who usually work full-time is above its pre-pandemic level; after the Great Recession, it took years to recover those jobs.
Having a job is the first step, but it’s the paycheck that helps people make ends meet. Wage growth is strong, averaging around 5%. That’s down a good bit from its peak in 2022 when businesses were scrambling to hire workers, but well above the pre-pandemic pace. And the gains are even bigger at the bottom. That’s important. Higher wages are how we will get past the higher prices, and we are making real progress there.
Again, a full employment economy is a good economy. We have a lot on the line now.
An economy at full employment like now means more hours worked, bigger paychecks and more Americans covered by health care and other benefits. All of those things have been crucial in alleviating the crunch of elevated consumer prices. The wages of most workers, especially those at the bottom, are now rising at a faster pace than inflation. Plus, faster productivity growth should help sustain wage gains above pre-pandemic levels.
That’s a big margin for errors by the Fed. The big interest rate increases are putting pressure on the labor market. However, the Fed has backed off the claim that a “softening” of the labor market and slower wage growth were necessary to bring down inflation. Good. That had been a refrain for almost two years. We are seeing some worrisome signs in the labor market; it’s not a sign of an imminent crash, and we still have a buffer, but something to watch.
American consumers keep going and going.
With the labor market firing on all cylinders, it should come as no surprise that Americans are still out there spending. Oddly, to many professional forecasters, it has been a surprise, but let’s set that side. I am not surprised.
Income, above all else, drives spending, and paychecks are the main source of income for most Americans. And spending is almost two-thirds of the economy. Despite a massive decline in inflation-adjusted spending in 2020—when the economy shut down and Covid made face-to-face services dangerous—by the summer of 2021, with the re-opening, the services spending safer with the vaccine, and more fiscal relief, spending returned to its pre-pandemic trend. It took several years after the Great Recession to reach that milestone. This time was different. Good!
Through November last year, inflation-adjusted spending had risen 2.7% year-over-year. That is a solid pace, comparable with the expansion before the pandemic. The goal is to settle into a sustainable pace of growth. The signs are good that we are either there or getting close.
Moreover, the improved finances of most households since the pandemic began will continue to allow them to weather high borrowing costs. The median inflation-adjusted wealth of families across all demographic and income groups made historic gains from 2019 to 2022, surging 37% thanks in part to fiscal relief programs enacted by Congress that allowed many families to save and pay down debt. The amount of excess savings, or savings relative to what would have been expected before the pandemic, remains elevated. For customers that had around $3,000 in bank account balances before the pandemic now have almost $13,000, according to Bank of America Corp. Chief Executive Officer Brian Moynihan. Debt burdens, whether relative to income or wealth, are near historic lows.
Some families are being left behind, and, on top of the higher inflation, the Fed’s rate hikes are hurting those who are taking out loans. Even so, the widespread improvements in finances are an important backup if the labor market falters.
Inflation is headed to 2%.
The biggest risk to the soft landing is the Fed. The sooner it gets out of the way, the better. And that only happens when inflation is back to target. The consumer price index has fallen from its recent peak of 9% in mid-2022 to around 3%. There is a case to make that the last mile to 2% may be the easiest; the first one sure felt like the hardest. There are more Covid disruptions than supply chains unwinding, such as labor shortages (with more labor), pent-up demand from closing the economy (revenge travel), and the surge in demand for goods relative to services. And the big wild card: when will the extraordinary pricing of businesses fade? If the last mile is the fast that will be the source.
The extraordinary pricing power businesses enjoyed during the pandemic and Russia’s invasion of Ukraine is still unwinding. As then Fed Vice Chair Lael Brainard posited last fall, ending the “price-price spiral” [or the sellers’ inflation from Isabelle Weber] could be another way to slow inflation without causing a destruction in demand that would damage the economy. But don’t worry too much about corporate profits. Growth in unit labor costs, while still elevated, has slowed since 2022, and producer prices have started to decline. The normalization in pricing power alone could get us the last mile of disinflation the Fed desperately wants to see before it cuts rates.
This channel is one that the Fed and most mainstream macroeconomists scoff at, especially if it’s labeled “greedflation.” I have come around to this idea, and we will soon know whether it’s reality. Here is my earlier post on it:
The temporary disruptions that have yet to unwind are a very important buffer for the soft landing. But we have been disappointed time and again at how slow the unwinding is. We have some notable momentum coming into 2023. And that’s very good, especially once the Fed gets it, too.
We have called off the recession hounds.
For the first time in two years, the consensus among forecasters is no recession. That was my call the entire time, as here in June 2022:
It’s extremely heartening to see the barking over a recession to soften some. Less pessimistic rhetoric is itself a buffer for the soft landing:
All this is perhaps why for the first time in two years most professional forecaster predict we will likely avoid a recession. Don’t forget that the extra gloom consumers have felt the last 12 to 18 months has largely been due to the unrelenting narrative that the “bottom will fall soon fall out” from under the economy. More optimism makes an expectations-driven downward spiral less likely. Already, widely-followed measures of consumer sentiment jumped in December, with the one from the University of Michigan surging the most since 2005.
Of course, we must remain vigilant. The case for a soft landing is much stronger than this time last year, but it’s not a slam dunk.
With the substantial progress on bringing down inflation, it’s time to cut interest rates. But even if the Fed delays acting, the many economic buffers in place should ensure that the economic plane lands softly, barring some unforeseen bad event.
The soft landing when we get it will not be the “triumph of hope over experience.” It will be the triumph over the harsh realities of the pandemic. Let’s go!
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