In a speech in Jackson Hole on August 26, Federal Reserve Board member Jerome Powell cast aside optimism that policymakers could engineer a soft landing for the US economy and avoid a recession. New goal: Avoid big crashes.
Powell suggested the Fed would keep its tightening policy longer and keep the economy grounded so that the current outbreak of inflation doesn’t turn into a chronic 1970s-style catastrophe.
“Returning price stability will take time and will require a strong use of tools to better balance supply and demand.”
So Powell let the air out of the Dow Jones.The Dow Jones suddenly dropped 1,000 points and continued to snowball.
But Powell’s excuse is why the economy is so bad today that an emergency landing is necessary. After all, inflation is past its peak and GDP is only falling continuously, rarely outside of a recession. Still, the Fed’s steady hand has done little to remedy the historic labor shortage and tight housing supply, and these imbalances continue to spur significant wage and rent growth.
The bottom line is that high inflation may not ease much until unemployment rises sustainably. Perhaps, once the Fed takes its foot off the brakes, a recession will be needed to create enough headroom to avoid inflation rising again. If we are headed for a hard landing, it will undoubtedly mean more turmoil for the Dow Jones and the stock market as a whole.
Will the labor force participation rate recover?
The U.S. economy seems almost run-out. With the unemployment rate at its lowest level in half a century and vacancies outnumbering the unemployed by more than 5 million, the labor supply appears to be plentiful. On the other hand, the housing shortage is causing a cost burden on families. In addition, it is possible that labor shortages will become more serious as people’s mobility becomes more difficult.
Friday’s August jobs report showed employers’ payrolls up by 315,000, suggesting hiring remains too strong for the Fed to feel relieved. At first glance, however, the report appeared to be a silver lining, perhaps pointing to a potential path to a soft landing. According to the Labor Department’s household survey, 786,000 people have entered the workforce. This means they are working or looking for work. This has pushed the unemployment rate up to 3.7%.
This was welcome news, as the workforce had shrunk in three of the previous four months. If the August rally is the start of a new trend, the Fed will have a better chance of rebalancing. But don’t be disappointed. In the 16–19 year old group, labor force participation increased by 331,000 his, adjusted for seasonal factors. On an unadjusted basis, participants fell by 500,000. Teenagers may have had summer jobs for weeks on end.
Most of the increase in the labor force occurred among young people aged 25 to 54. That’s good news, but the problem is: The employment rate among working-age adults in their prime has jumped to 80.3%. This is just off the pre-Covid peak of 80.5%, which was the highest since 2001.
Here’s the big picture: Labor force participation has rebounded significantly among those under the age of 65. Meanwhile, most of the growth in the adult population is occurring among those over the age of 65. It’s not clear where the extra workers will come from, and higher wages may be needed to attract them into the labor market. That wouldn’t go well with the Fed.
chronic labor shortage
The working-age population has increased by 4.5 million since February 2020, just before the Covid outbreak, but 130,000 fewer have jobs, according to Labor Department data. But as of July, the number of unemployed was the lowest he’s had at any time since 2000, with the labor force down about 15%.
Aging demographics account for a large part of the labor shortage. The population aged 65 and over has grown by just over 3 million over the past two and a half years, accounting for about two-thirds of the overall increase in the working-age population. But older Americans are less likely to work than they were pre-Corona. An analysis by the IBD found that falling labor force participation rates for those over 65 have reduced his rank of available workers by more than 600,000.
Aneta Markowska, chief financial economist at Jefferies, told IBD ahead of the August jobs report.
Markowska expects the U.S. economy to start succumbing to Fed tightening by early next year “when the labor market slack is completely gone and there are no people to hire.”
Need a recession?
Peter Hooper, Deutsche Bank’s global head of economic research, told IBD that a soft landing is “nearly impossible in my opinion.”
“For inflation to reverse, labor cost inflation will need to drop significantly,” he said.
Problem: Hooper and his colleagues estimate that the natural or non-inflationary unemployment rate is “currently slightly above 5%.”
This is well above the 4% unemployment rate that the Fed has long assumed to be inflation-neutral. Now he’s even above 3.5%. Getting there would require a rise in the unemployment rate much larger than the 0.5 point increase considered the minimum recession threshold.
In other words, the labor market is not simply tight. Hooper claims it’s not working as smoothly as it did before the pandemic. That view is fairly widely shared.
“Broadly speaking, many economists think the natural rate of unemployment will be much higher than it was before,” Powell said on July 27.
Pre-Covid, the unemployment rate had fallen to 3.5%, while wage growth was just over 3%, with no apparent inflationary impact. Now, with the same ballpark unemployment rate, wages have increased by over 5% a year.
Why it’s hard to find workers
So what has changed? In short, it’s getting harder to match the available workers with the jobs on offer. In February 2020, he hit a record high of 1.2 job openings per unemployed person.
Hooper attributes this in part to mass retirements of “older, more experienced workers.”
Declines in immigration, both due to policies introduced under President Donald Trump and Covid restrictions, are also having a negative impact on labor supply and matching, he says.
Hooper said the difficulty of obtaining affordable housing in many geographies has made the labor market even less flexible.
The National Association of Realtors’ Housing Affordability Index fell to its lowest level in 33 years in June. Monthly mortgage payments surged 54% year-over-year due to the double rise in mortgage rates and home prices.
A sharp drop in affordability should ultimately put downward pressure on home prices, but so far homeowners have responded by deciding to keep the status quo.
From the mid-1990s to the mid-2010s, sales of existing homes generally exceeded 2 million units, and during the housing bubble and subsequent crisis exceeded 3 million units. Single-family homes and condos for sale fell in the 1.5 million to 2 million range pre-Covid. However, housing stocks fell to just 1.3 million units in July after the pandemic.
Second-hand home sales in July fell 20% year-on-year to 4.8 million units, the lowest level since 2015. Still, median house prices have risen 10.8% since July 2021.
Meanwhile, sales of new single-family homes fell 30% year-on-year to 511,000 units, the lowest level since 2016.
Although the supply of homes on the market has surged relative to current sales, a long-term shortage remains.
Tailwind for millennials
There is also a demographic component to the housing shortage. 1989 to 1993 was the year with the most millennials with more than 4 million births per year. This group began when he was 33 years old. Unsubsidized housing renters, according to RealPage.
Demand tailwinds from millennials followed a 12-year slump in housing construction that ended in 2019.
According to Realtor.com, the number of US households increased by 13.8 million from 2012 to 2021.
Rent surge fuels core inflation
That helps explain the surge in demand for apartments: National vacancy rates fell from 6% before the pandemic to 3.9% in July, according to RealPage. The rent of the newly signed rental property rose 17.2% compared to the rent of the previous tenant, but the one who renewed the lease paid 11% more.
Rent growth and high occupancy rates have started to moderate from their recent peaks. This he should continue into 2023 with a bountiful harvest of new developments.
Still, Markowska expects “significant rent increases to continue for at least another 12 months,” as wage growth keeps demand up.
CPI inflation began to moderate in July, dropping from 9.1% to 8.5% on lower gas prices. However, non-energy service inflation reached his 5.5%, the highest in three decades. These categories, including shelter costs, medical services, transportation and education, account for 57% of household budgets.
Core inflation is unlikely to fall to the Fed’s 2% target until labor shortages and wage pressures abate.
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An emergency landing for the US economy
As Powell said on August 26th, the Fed needs to plan an emergency landing, even if it means a recession, because the labor market is “clearly out of balance.”
The message of his Jackson Hole speech is that the US economy will likely need to remain stable for some time.
The Fed is focused on not repeating the mistakes of the 1970s, he said. At the time, policymakers let their guard down every time the U.S. economy faltered and watched inflation reignite. Ultimately, 20% interest rates and 10% unemployment are needed to soften the threat of inflation.
“Our aim is to avoid the consequences by acting decisively now.”
That’s why the Fed’s new stance derailed the Dow Jones rally. Before Powell changed the script, investors saw good economic news as bad news for stocks. But they hailed bad news as good news.
But suddenly, “bad news is also bad news,” writes Swissquote bank analyst Ipek Ozkardeskaya.
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