Update 661 — A Soft Landing in 2023?
Jobs, CPI, Tracking Fed Plane in the Sky
As we enter a new year, the economy appears to be on the mend. Last year, inflation began accelerating and stayed elevated throughout. As yesterday’s CPI report makes clear, prices continue a descent thanks (only in part) to the Fed’s actions to tame inflation. The economy, job market, and consumer activity remain strong in spite of its aggressive rate hikes. The US currently enjoys its lowest rate of unemployment in half a century.
The CPI report also points to a widening lane for a soft landing, raising hopes the Fed might be able to bring inflation to target level without adversely affecting employment. Should it succeed, not only will this be a boon for the economy, but will lift the I-monkey off Democrats’ backs heading into the 2024 political cycle. Today, we discuss the December Jobs and CPI reports, and what they mean for the trajectory of the economy.
Good weekends all,
The Federal Reserve has been working for quite some time to tame inflation, and December’s Jobs and CPI reports indicate that they may have a method to their madness after all. After a series of consecutive rate hikes and unnerving whispers from Wall Street, last month’s reports – which showed the lowest unemployment rate in half a century and the CPI decreasing 0.1 percent month-over-month, thereby bringing the year-over-year change to 6.5 percent – capped off a year full of positive job growth and overall decent movement for the US economy. The numbers in these reports should give the central bank some solace, as they demonstrate resilience in the labor market.
As we head into the new year, it is critical that the Fed thread the needle in regards to interest rates after a year of rapid increases. The country’s supply chain woes, which were exacerbated by the pandemic, are beginning to ease, and Treasury Secretary Janet Yellen also expressed optimism this morning that rent prices would start to come back down within the next six months. If current trends continue, the Fed won’t need to continue hiking rates as aggressively this year.
Year-Over-Year CPI Inflation (Percent)
Source: Bureau of Labor Statistics, Axios
Jobs On the Rise
The release of last week’s jobs report was a reason to rejoice for many, as the jobs numbers far exceeded economists’ grim expectations. Following a period of heightened recession fears paired with unsettling GDP numbers in the first half of the year, 2022 wrapped up in a relatively positive light. We can only hope 2023 has even more in store.
Last month’s numbers showed nonfarm payrolls increasing by 223,000 and unemployment falling to 3.5 percent, with the number of unemployed individuals sitting at 5.7 million. This is a welcomed surprise, as many were expecting a number around 202,000, per a recent Bloomberg survey. While a wide array of sectors experienced some notable gains, the following industries had a particularly encouraging month:
- Leisure and Hospitality: The leisure and hospitality industry added 67,000 jobs, with employment trending upwards in food services/drinking places, as well as in amusements and accommodations.
- Health Care – Employment in the healthcare industry rose by 55,000 in December. A strong number rounded out the year, with healthcare averaging 49,000 per month in 2022 compared to 2021’s average monthly gain of 9,000.
- Construction – Construction added 28,000 jobs in December alone. Employment for this industry increased by an average of 19,000 per month, up 3,000 from the year prior.
- Social Assistance – Last but certainly not least, social assistance increased employment by 20,000. In a similar fashion, 2022 demonstrated an average monthly gain of 17,000 jobs per month compared to last year’s average of 13,000 per month.
Wage growth showed signs of slowing down, as average hourly earnings rose by 0.3 percent month-over-month in December and 4.6 percent year-over-year. This slow down should help convince the Fed that there is not a need to drive up unemployment in order to diminish workers’ ability to demand better compensation.
The Consumer Price Index (CPI) decreased 0.1 percent month-over-month in December, thanks in large part to falling gas prices. Headline CPI increased by 6.5 percent year-over-year, in line with market expectations. This is both the slowest increase since October 2021 and the third month in a row that year-over-year headline inflation has decreased compared to the month before, as supply chain issues stemming from the pandemic continue to ease.
Contributions to Monthly Headline CPI
January 2019-December 2022 (Percentage Points)
Source: Bureau of Labor Statistics, Council of Economic Advisors
Core CPI, the index for all items less food and energy, rose by 0.3 percent month-over-month, driven largely by increases in the index for shelter. Shelter rose 0.8 percent for the month and accounted for over half of the increase in year-over-year CPI. However, shelter prices are a lagging indicator, and there are signs that rent and home prices are on their way down, which should help drive inflation down even further in the coming months.
Increases in the food index have continued to slow, good news for consumers. After a 0.5 percent increase in November, the index for food rose by only 0.3 percent in December. Food at home rose only 0.2 percent, following a 0.5 percent increase in November. Although the rising price of eggs did drive an increase in the index for meats, poultry, fish, and eggs, December saw decreases in the index for fresh fruits and vegetables, as well as the index for dairy and related products. This was a welcome change for shoppers who have been hammered by price increases at the grocery store.
The indexes for household furnishings and operations, motor vehicle insurance, recreation, and apparel indexes also increased in December, while the indexes for used cars and trucks and airline fares decreased.
This month’s CPI report is a positive sign that inflation has started to cool, and that the Fed can continue slowing down the pace of its rate increases.
A Soft Landing?
December’s jobs and CPI reports are a sign that the Fed doesn’t need to keep aggressively hiking interest rates in the new year. Between the Fed’s rate prior increases and easing supply chain issues, inflation is already beginning to cool down. Short-term inflation expectations continued to decline in December, and the outlook for a soft landing seems to be increasing.
That said, the Fed must take care not to push the economy too far. Federal Reserve Chair Jerome Powell has stressed that bringing down inflation is his top priority, and that reaching the Fed’s target of 2 percent inflation will require ongoing increases in the federal funds rate in order to bring labor demand back in line with supply. Projections from FOMC participants in December indicate that under what they consider to be “appropriate monetary policy”, unemployment has the ability to rise by nearly a full percentage point in 2023. At a December press conference, Powell claimed that this increase would not necessarily be recessionary due to a projected .5 percent increase in GDP. Historical precedent would indicate otherwise.
While the unemployment rate has remained low, hovering between 3.5 and 3.7 percent since March of last year, and labor demand has remained high, the level of wage growth that we saw in December is not indicative of a wage-price spiral. As long as wages continue to grow at a reasonable pace, there is no real need to drive up unemployment as a solution to high inflation, particularly when the risk of recession is so high.
Waiting on the Tarmac
With the possibility of Fed policy tipping the economy into recession still a live one, many of us are watching the Fed’s next move. Although these end of year reports are something to celebrate, we are not quite out of the woods yet. Soft landings are notoriously elusive, and the Fed must be cautious not to overcorrect. Barring further shocks, a soft landing could very well be in sight, but time will tell whether the Fed knows when to quit.
At the same time, Congress and the White House should be sure to continue working to shore up supply chains, which are beyond the power of the Fed. The investments from the Chips and Science Act are an excellent start, but insulating our supply chains from future shocks will be a long-term project.