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The latest bevy of government data shows prices are declining, wage growth has slowed and people aren’t spending like they used to.
By all appearances it seems inflation is, indeed, being tamed. But at this point it’s still uncertain whether the U.S. is in the clear or instead glimpsing a recession on the horizon.
Kathryn Anne Edwards, an economist, independent policy consultant and adjunct at Rand Corp., uses a “bad week” analogy to describe the economic situation.
“In this fight against inflation, we’re in a perpetual state of Wednesdays,” Edwards says. “It’s midweek. We know we’ve had kind of some bad days and we’re on the hunt for any further evidence of how this week is going to go, but it’s not Friday yet. By Friday we’re going to know if it’s been a terrible week or not; by Wednesday it could still go either way.”
In an ideal scenario, inflation keeps trending downward without meaningfully increasing unemployment. Prices stabilize and we celebrate avoiding another recession.
That’s a distinct possibility, since the labor market continues to remain incredibly tight even in the face of higher prices for you-name-it. Unemployment is at an astounding low of 3.4%, quit rates remain elevated and job prospects are abundant even as wage growth moderates and layoffs start to hit certain industries.
“The verdict is still a little bit out, but it’s leaning toward a brighter economic picture,” says Nela Richardson, chief economist at ADP Research Institute.
All in all, it looks like economic conditions are starting to head in the direction the Federal Reserve wants them to. The central bank has responded by raising the federal funds rate by only 25 basis points on Wednesday — lower than the previous 50-basis-point hike in December and the four previous 75-basis-point hikes earlier in 2022.
A smaller rate hike by the Fed is good, but it also makes clear the Fed isn’t quite satisfied. It’s highly likely at least “a couple” more hikes are to come, Fed Chair Jerome Powell said during a Feb. 1 press conference. The Fed has a 2% inflation target, and the current rate sits at 6.5%. Powell said the Fed needs “substantially more evidence that inflation is on a sustained downward path.”
“It would be premature to declare victory or to think we’ve really got this,” Powell said.
Wage growth is moderating
Wages, salaries and benefits saw their smallest quarterly increase in over a year in a sign that wage growth is starting to ease. The latest Employment Cost Index, which measures wage and salary growth, showed quarterly labor costs increased by just 1%, compared with 1.2% in the previous quarter. Labor costs increased 5.1% year-over-year for the fourth quarter of 2022, while the previous quarter showed a 5.2% year-over-year increase.
But labor costs are still not where the Fed would like them to be — at most a 3.5% annual rate, as they were pre-pandemic. Powell indicated during Wednesday’s press conference that there may need to be some “softening” of the labor market. But that was before the latest jobs report was released.
Of the lowest unemployment rate in more than 50 years, Richardson says: “If the Fed was looking for a soft landing, it’s almost like the economy pulled out an air mattress; this is more than soft, this is a cushy landing.”
But Richardson also says it may be too soon to tell what the economic trajectory is.
“We’ll see if these trends persist through the new year,” says Richardson. “Like everything, the labor market is evolving so quickly, so paying attention to wages, labor force participation and monthly wage gains is going to be important to understanding all the dynamics at play now.”
Lower wage growth isn’t ideal for workers, of course, especially since wages still aren’t keeping pace with inflation. “There’s been a decrease in pressure on wage growth, and that’s good for the inflation story, but I wouldn’t say it's necessarily good for American households,” Edwards says.
Richardson says it’s likely the lower wage growth is due to increased hiring in lower-paying service sectors, rather than the rate of wage growth in professional industries.
Labor market remains strong despite some layoffs
The labor market remains hardy. The unemployment rate for January is 3.4%, according to the Bureau of Labor Statistics' Feb. 3 jobs report, slightly lower than December’s rate of 3.5%. Quit rates, which represent workers’ willingness to job hop, held steady at around 2.7% for most of 2022, though down from 3.0% in December 2021.
You’ve likely seen headlines over the last few months about layoffs, especially in specific industries. The hardest hit have been in tech at companies like Amazon, Google, Microsoft, Meta and Twitter. Media has also seen layoffs recently at the likes of CNN, NBC, Vox and The Washington Post.
But the Bureau of Labor Statistics’ latest Job Openings and Labor Turnover Survey, or JOLTS, report shows that overall the rates of layoffs changed little month to month in 2022 (ranging from 0.9% to 1.0%), even though they are up slightly from a year ago (0.8%). And there was job growth in January that far outpaced any layoffs.
“Right now a weak labor market is not something you have to worry about,” says Richardson. “If you are unlucky enough to experience a layoff as a worker, it looks like you're being laid off in a market where you can get a job, sooner than if the economy was in a recession.”
And certain industries have more openings than they can handle. Most notably, hospitality and leisure; government; and retail trade have still not returned to pre-pandemic staffing. And some employers are looking to hire even more workers. The fast food giant Chipotle, for example, recently announced it would be hiring 15,000 restaurant staff members.
Inflation is decelerating
The Consumer Price Index, or CPI, is considered a proxy for inflation and has shown annual inflation above 5% since May 2021 — the seventh period of high inflation since the Second World War.
But the CPI has been declining for months. The December report showed CPI increased by 6.5% year over year, compared with 7.1% year over year in November. And the current increase is significantly lower than in June 2022, when the year-over-year increase peaked at 9.1%.
The ease in price growth is making a difference for consumers. Gas prices, for example, aren’t quite as low as they were about a month ago or even a year ago, but they’re still about 30% cheaper than last summer when they peaked at an average of $5.006.
The core personal consumption expenditures price index, or core PCE, the Federal Reserve’s preferred measure of inflation, tracks how consumers alter their spending habits in response to price changes to goods and services. The core PCE excludes food and energy. The Jan. 27 report from the Bureau of Economic Analysis shows that growth in the core PCE index is slowing: It increased 4.4% year over year in December compared with 4.7% year over year in November and 5.1% year over year in October. This signifies that spending is shifting downward.
However, the downward shift in prices isn’t solely due to the Fed raising interest rates, which is what makes inflation all the more unpredictable. Supply chain woes have eased, which has helped bring down the costs of products. And as Edwards points out, certain price changes are not syncing up with all of the others. The reason eggs are more expensive, for example, is not because of excess consumer demand, but because there’s been an avian flu killing birds.
Consumer behavior is changing
While stuck at home during the pandemic’s first year, consumers padded their savings and online shopped till they dropped. As restrictions began to dissipate, people poured money into restaurants and travel. Meanwhile home sales went through the roof and auto dealers, stymied by a chip shortage, couldn’t keep up with demand.
But inflation started eating up gains in wages and savings during 2022, so much so that habits are starting to shift, according to government data.
People are now spending less on goods and more on services. Real consumer spending — the total amount of consumer spending adjusted for inflation — and spending on consumer goods both declined in December, according to Bureau of Economic Analysis data from Jan. 27. Retail sales, including e-commerce, are starting to dip from their October 2022 peak, according to the latest U.S. Census Bureau data analyzed by the Federal Reserve Bank of St. Louis. Spending on homes and vehicles has slowed, too.
Consumers are still spending on services, led by housing and utilities, as well as transportation and health care, according to Bureau of Economic Analysis data.
Meanwhile, savings gains made over the last few years have slowed. Personal savings have declined dramatically from their peak in April 2020 — the current savings rates are closer to where they were in March 2008, according to Bureau of Economic Analysis data.
Those who borrowed to pay for cars, homes and travel can expect to have a more difficult time repaying their debt. That’s because of the rate increases by the Fed, which pushed interest rates to a target range of 4.5% to 4.75%. And with additional hikes on the way, it’s going to make debt much more expensive for borrowers to repay.
There’s no wage-price spiral
Wage growth isn’t keeping up with price growth. As mentioned earlier, that seems bad for workers in the short term, but it may be better than the alternative, at least according to economic theory. The current pace of wage growth isn’t so fast compared with prices for goods and services that we’ll end up in a doom loop where inflation grows out of control.
As prices increase and demand for labor stays high, businesses offer higher wages in order to hire and keep workers. This is basic supply and demand. And in the current economic environment, where there is low unemployment and workers have lots of job options, it benefits workers.
Where this scenario could, theoretically, get out of hand — and evolve into a dreaded wage-price spiral — is if both consumer prices and nominal wages continue increasing. But that’s a highly unlikely scenario; U.S. Treasury Secretary Janet Yellen told Bloomberg on Jan. 27, “We’re not seeing a wage-price spiral.”