Evening Brief – 05.25.23

It is likely to require a further decrease in labor income growth if inflation is to return to the Fed’s 2% target. Despite Covid-19 stimulus programs and changes in borrowing habits, consumer spending has largely followed wage growth since the beginning of 2021. Unsustainably high spending growth is a natural byproduct of quickly rising household earnings, which need to slow for inflation to return to its target level of 2%.

Nevertheless, without going into a recession over the past year, the labor market has cooled. Without a rise in the unemployment rate, growth in average hourly wages fell to 4.5% from 6%, and the Employment Cost Index – a Fed favorite – fell to 5% from 5.7%.

Leading indicators of both income growth and the health of the labor market have been declining. From a high of 4.5 million in early 2022, the number of workers resigning each month has dropped to 3.9 million, and in recent months the number of people laid off has increased to pre-pandemic levels. Continuing jobless claims are also still above levels seen in late 2022 and more in line with pre-pandemic trends.

The FOMC’s median forecast for the unemployment rate in March was 4.5% at year-end, which was only marginally more optimistic than the December 2022 forecast of 4.6%. As time passes, those predictions appear more improbable. By the end of the year, the unemployment rate would need to increase by more than 0.1% every month to reach 4.5%, which would imply hundreds of thousands of jobs lost each month.

The economy has so far proven more resilient to rate hikes than was initially anticipated, which has both lengthened the time for fighting inflation and decreased the still-high odds of a recession.