Economic ‘soft landing’ looking likelier as inflation eases and employment grows
Zachary Halaschak
An encouraging inflation report for December, coupled with news of labor market resiliency, is raising hopes that the economy might avoid a recession as it emerges from inflation.
Annual inflation slowed to 6.5% in the 12 months ending in December, the Bureau of Labor Statistics reported Thursday. On a month-to-month basis, prices fell by a tenth of a percentage point. That was right in line with expectations and shows that inflation is cooling, meaning that, so far, the Federal Reserve has been able to hike interest rates without substantially harming the economy.
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The Fed has been hiking rates for nearly a year. After several massive 0.75% hikes, the central bank has begun to slow its upward revisions. While most economists forecast at least a mild recession in the coming months, some are becoming more optimistic about an elusive “soft landing” in which a recession is avoided.
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In addition to headline inflation falling by more than half of a percentage point on an annual basis, “core inflation,” which strips out volatile food and energy prices, fell three-tenths of a percentage point to 5.7% in the year ending in December.
“These data show what everyone already knew — inflation peaked several months ago, and we are on the road back to stable prices,” said Jamie Cox, a managing partner at Harris Financial Group. “The Fed has a real chance of sticking the soft landing if these data continue to fall at current rates — it’s very possible we could reclaim 2% inflation by mid-year.”
The inflation numbers are complemented by the strength of the labor market despite the powerful headwinds of a rapidly rising Fed target rate. Conventional wisdom indicates that job creation should noticeably slow down or turn negative as a result of the rate hikes, but the labor market has thus far managed to defy gravity.
The economy added 223,000 more jobs in December, the BLS reported last week. The unemployment rate fell to 3.5%, a jaw-dropping number that is tied for the lowest rate since the late 1960s.
In addition to months of strong job creation, the prospects for the next few months look good, as the number of people applying for jobless claims each week (a forward-looking indicator of the labor market weakening) also shows no evidence of seriously increasing. Last week, jobless claims were at 205,000, a decline from the most recent peak of 261,000 last July.
“On balance, the claims data are consistent with a labor market and wage pressures that are still too tight for the Fed and leave the Fed on track to raise rates further in 2023,” said economists with Oxford Economics.
Job openings have also not been plunging as conventional wisdom would suggest.
Openings across all sectors declined just slightly to 10.46 million in November, down from 10.5 million the month before, according to data released last week. Hires were little changed in November, as were layoffs. The rate of people quitting their jobs was also about the same as the month before.
Central bank officials, meanwhile, have said that it will be necessary for the labor market to soften a bit to bring down inflation. Fed Chairman Jerome Powell has said that openings “need” to come down. The latest data suggest that he may have been overly pessimistic.
Markets immediately reacted to Thursday morning’s CPI report. The Dow Jones Industrial Average and the S&P 500 both rose in response to the news that inflation is meaningfully declining.
The market’s sigh of relief was also captured by the Chicago Board Options Exchange Volatility Index, better known as the VIX and the “fear index.” The VIX was down about 8.5% on Thursday — although it has been up by about 10% since this time last year.
Investors also bet that the Fed won’t be as aggressive with its tightening when it meets later this month in Washington to decide what to do next with its target rate.
Investors are now pegging the odds of a 25-basis-point hike at more than 90% and pricing in just a 9% chance of a 50-basis-point hike, according to CME Group’s FedWatch tool, which calculates the probability using futures contract prices for rates in the short-term market targeted by the Fed. Just a day before, investors only assigned 77% odds of the lighter hike, and a month ago, a slight majority expected a 50-basis-point hike.
There were some concerning parts of December’s consumer price index report, though. The housing component of CPI, which includes rents, household furnishings, and energy bills, rose 8.9% over the past year. Housing carries a big amount of weight in the CPI calculation, and high housing prices are causing home sales to plunge by the most they have in years.
“The upshot here is that fewer household budgets are taking on the expenses encompassed by the still-accelerating Housing component of CPI. But for the many who purchased homes in 2020 and 2021, rising costs will continue to erode household finances, which sets the stage for consumers hitting a wall in their spending capacity by mid-2023,” said PNC senior economist Kurt Rankin.
Most economists continue to see a recession as more likely than not.
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A Bankrate survey of economists conducted each quarter found that those polled placed the odds of a recession at 64% over the next year to year and a half. A monthly Bloomberg survey of economists found that there is about a 70% chance of a recession, more than double what was predicted six months ago.
The central bank’s Federal Open Market Committee will hold a two-day meeting at the end of the month and will announce its next move for the federal funds rate on Feb. 1.