By Jeanna Smialek
An object that is in motion continues to move. Does a labor market trend that’s currently in motion differ in any way?
That’s the question that Federal Reserve officials face as they attempt to accomplish a task that has historically been difficult: gently tempering an economy grappling with rapid inflation without adversely affecting the job market.
As of now, the Fed’s endeavor for a smooth transition is progressing more favorably than anyone anticipated, including the central bankers themselves. Inflation has notably decreased, with the consumer price index falling to 2.5% from a peak of 9.1% just two years prior. Even with the Fed’s policy interest rate at its highest in over 20 years, consumer spending has remained robust, and overall growth continues to steadily advance.
Fed officials are keen to maintain this momentum. This is the rationale behind indications suggesting they will reduce interest rates at the close of their meeting on Wednesday — with the primary consideration being whether they will opt for a standard quarter-point cut or a half-point reduction. They are also expected to project further rate cuts before year-end, potentially indicating a full percentage point decrease from the current 5.33%.
Yet, even as the Fed navigates a pivotal moment in its inflation battle, tangible risks persist. The focal point of these risks lies in the labor market.
Unemployment has been gradually rising. Wage increases have been consistently diminishing. Job vacancies and hiring rates have decreased simultaneously. While these trends align with the Fed’s intentions—to cool an overheating job market and prevent a resurgence of inflation—central bankers have explicitly stated that they do not wish for this cooling to persist.
“We do not seek or welcome further cooling in labor market conditions,” stated Fed Chair Jerome Powell in his latest address.
The challenge lies in the unpredictability of what, precisely, will halt the evident slowdown occurring within the labor market. Fed rate reductions could bolster business morale and invigorate demand, yet adjustments in central bank policy function similarly to slow-release medication. They do not catalyze immediate change in the entire economy.
That’s why some observers are beginning to express concerns that the Fed may lag in its response if it reacts too slowly — a situation that could lead them to scramble in lowering borrowing costs swiftly enough to avert significant job market distress.
“Not all slowdowns lead to recessions, but all recessions start with slowdowns,” remarked Skanda Amarnath, executive director at Employ America, an organization dedicated to employment research and advocacy. “I believe the data is indicating a level of urgency.”
The Fed has approached interest rate reductions with caution so as to not risk prematurely or abruptly easing economic restraints, which could allow the economy to heat up again, complicating efforts to eradicate inflation fully.
However, this carefulness on the inflation front may lead to risk-taking regarding employment.
The most alarming indicator of labor market decline has been the recent surge in unemployment. After slipping to 3.4% in 2023, it rose to 4.2% by August, a change driven both by individuals leaving their jobs and new entrants taking longer to secure employment.
The key uncertainty is whether the forthcoming shift in Fed policy will suffice to abruptly halt the gradual uptick in unemployment. Though it paused in August, this slow increase has persisted since last summer.
The same concern extends to wage growth, a reflection of how fiercely companies are striving to hire. In a robust job market where employees are scarce, businesses typically increase pay to attract talent or retain their staff. Conversely, as the job market softens, wage growth decelerates.
That’s the current scenario. Average hourly earnings for non-supervisory workers have decreased from a high rate of 7% growth in 2022 to a more subdued 4%. This remains quicker than pre-pandemic rates, although only marginally: Wage growth was around 3.7% in the summer of 2019.
Additionally, notable changes have been occurring in job openings. They have steadily declined, returning to levels seen before the pandemic. This trend is significant because historically, unemployment typically rises as job openings decrease, a correlation economists refer to as the “Beveridge Curve.”
Indeed, research from the Dallas Fed this year has warned that joblessness could increase, suggesting that “the drop in job vacancies without a corresponding rise in unemployment may not be sustainable.”
Despite the accumulation of signs indicative of a weakening labor market, Fed officials have conveyed that there are grounds for optimism that this situation may be different.
Previous efforts by the Fed to contain inflation by cooling the labor market have resulted in severe recessions, a prime example being the consecutive downturns experienced in the early 1980s.
Historical economic patterns suggest that rising unemployment often foreshadows a recession, as those without jobs and anxious workers tend to reduce their consumption.
However, the distinct upheaval caused by the pandemic has led economists to propose that what is transpiring may be a gradual return to normalcy, rather than an intense contraction.
“It should be evident that many economic relationships from before the pandemic have not served as reliable indicators for policy in the post-pandemic landscape,” stated Christopher J. Waller, a Fed governor, in a recent speech. “Although I don’t perceive the recent data as indicative of an impending recession, I do identify some downside risks to employment that require close monitoring.”
For example, Fed officials frequently emphasize that part of the recent uptick in unemployment can be attributed to a surge of new entrants into the workforce, rather than an alarming rise in layoffs. While layoffs are on a gentle uptick, they haven’t seen a sharp increase.
This is why some economists remain hopeful for a smooth transition — especially if the Fed acts promptly.
Fed officials are contemplating a more significant rate cut this month specifically because they are aware of the risks present in the job market. Even if they opt against a drastic reduction, they are likely to hint at forthcoming rate adjustments, and the possibility of a substantial rate cut at their next meeting if warranted by the data remains on the table.
“If employment deteriorates further from this point, they will have no choice but to — ultimately — implement a half-point cut,” remarked Diane Swonk, chief economist at KPMG. “The crucial takeaway is that the Fed, and Powell, is clearly intent on achieving the soft landing. This is his legacy.”
