Posts in category: Economic Development

submitted by
Uric Dufrene, Ph.D., Interim Executive Vice Chancellor for Academic Affairs, Sanders Chair in Business, Indiana University Southeast

Last year saw close to unanimity regarding the 2023 outlook and a chance of a recession.     In fact, the 2023 recession may have been one of the most predicted recessions.   The 100% chance of a recession has yet to arrive, and with last Friday’s labor report, the recession that everyone expected will be delayed once again.

The consensus estimate for job gains was around 180,000 and the report showed an addition of 253,000.   Even a gain of 180,000 would be considered very strong and the reported result exceeded that.   The largest job changes occurred in professional and business services (+43,000), health care (+40,000) and leisure and hospitality (+31,000).  Manufacturing added 11,000 jobs, even with the latest ISM report on manufacturing showing contraction in the  sector.  The unemployment rate remained little changed at 3.4% and there was no change to labor force participation. Perhaps the worst part of the report was about the revision of March payrolls.    March was revised downward, from 236,000 to 165,000.

This Wednesday brings the Consumer Price Index release.   The report is expected to show additional moderation in inflation, but core inflation (inflation minus the cost of food and energy) may be sticky, one of the driving factors behind the last interest rate increase of 25 basis points.  The preferred Federal Reserve indicator on inflation, the PCE Deflator, showed additional deceleration, but the numbers came in a little higher than expected.  Despite the Fed concerns about inflation and guidance that shows the continued maintenance of higher rates, markets are expecting the Fed to begin cutting rates later this year.  This is driven by the market view of an expected recession or slowdown later in the year.

Unemployment claims continue to run at levels that do not coincide with a recession.   The labor market is showing some signs of slowing or softening, but with new claims running at 242,000, more layoffs need to occur before we get close to the declaration of a recession.  Job openings plummeted last week with the release of the JOLTS report but remained higher than the number of unemployed.  The latest report showed that approximately 1,7 jobs exist per unemployed person.

Locally, the metro area is approaching 700,000 non-farm payrolls.  The latest metro employment report (subject to subsequent revisions) showed that metro area payrolls are at the highest in history, at 689,000.  This is about 9,000 higher than the level that existed just prior to the pandemic.   The unemployment rate for the metro region is at 3.1%, among the lowest in the past 30 years.

The most anticipated recession has yet to arrive.   Unless there is a dramatic fall in job changes, a recession this year is getting increasingly unlikely.   There are risks to the economy, and I continue to believe that a slowdown is coming.   A slowing economy may still escape an official recession, however, at least for this year.

submitted by
Uric Dufrene, Ph.D., Interim Executive Vice Chancellor for Academic Affairs, Sanders Chair in Business, Indiana University Southeast

One could argue that housing has perhaps been most impacted by current Federal Reserve monetary policy. With inflation at a forty-year high, the Fed finally began lifting the target Fed Funds rate, with the goal of suppressing demand and thus slowing down the rate of inflationary growth.  Fed policy impacts mortgage rates, which bottomed out in early January 2021 at 2.74% and peaked in late 2022 at 6.81%.

The origins of the current housing market take us back to early 2020.  The Covid pandemic threatened economic collapse, along with high levels of uncertainty.   This was not the same as the Great Financial Crisis or prior recessions.  There was not really a playbook.   The Fed responded with a drop in the Fed Funds target rate from 1.75% in March 2020 to 1.25%.  The rate would be lowered again to .25% by the end of the month.

In early 2020, the 30-year mortgage rate was approximately 3.6%.   Looser monetary policy drove rates down to 2.8% almost a year later.   Record low mortgage rates, along with significant government stimulus, combined to ignite home prices. In early 2020, the median selling price for existing homes, using National Association of Realtors data, was $272,800.   Home prices peaked in June 2022 at a whopping $420,900!

As the old expression goes, hindsight is 20-20, and there is never a shortage of armchair quarterbacks.   But any rational economic thinker can only wonder how the Fed could manage to make such a glaring policy error.     In early 2020, the target Fed Funds rate was reduced to almost 0, and with the economic shock that nation’s economy was experiencing, you could make the case that this was necessary.    For the next 18 months, the policy decisions are nothing less than bewildering.  The target Fed Funds rate of  .25% was held at that level all the way until March 2022.   In early 2020, inflation, as measured by the CPI, was less than 1%.  No doubt, the Fed feared the onset of deflation, a crippling phenomenon that devastates profits and magnifies the impact of any leverage.   The looser monetary policy was very justified during this early phase of the pandemic.

After hitting bottom around May 2020, inflation then started to creep up again.  Recall the supply chain issues and the gargantuan government stimulus that stoked demand.    A year later, the CPI would be running at almost 5% inflation.    Inflation was running hot, but the Fed refused to budge on the Fed Funds rate.   In May 2021, the Fed Funds rate was still at .25%.   By the end of 2021, inflation would be running at 7.2%.  The Fed Funds rate was still at .25%.    Inflation peaked  June 2022 at 8.93%, but the Fed did not increase the target Fed Funds rate until May 2022, a month before hitting the peak in inflation.

We can see the impacts of these national decisions on local housing, although the impact has not been as severe as the national landscape.   Over the first quarter of 2023, national existing home sales have dropped 38% compared to the first quarter of 2022.  In Clark and Floyd county, home sales have only declined by 14.2% and 6.8% respectively.   Home prices are on the decline nationally, as mortgage rate increases have snuffed out demand, and owners of low mortgages are reluctant to sell, thus impacting the supply of homes.   The National Association of Realtor’s price data show that the average price of existing home sales is about flat from first quarter 2022 to the first quarter of 2023.     This year- over-year comparison does not capture the June 2022 peak of $420,000.   Prices have fallen fast since June but remain flat when compared to early 2022. In Clark and Floyd, home prices are up 5.7% and 15% respectively.   Despite higher mortgage rates, local home prices remain in positive territory, likely due to the supply of homes available for sale.   Homes available for sale have increased, with the months supply of inventory increasing to 1.6 and 1.4 for Clark and Floyd respectively.   This is up from 1.0 and .8 from a year ago, but still at very low levels.

Locally, we do see the impact of federal policy on building permits, having a definite impact on activity.   Clark County has always been the leader in building permit activity, given its role as the most populous county among the five Southern Indiana metro counites.   In 2021, Clark County generated 1,626 building permits, with 716 of that level in 5+ units multi-family housing.   In 2022, permit activity declined to 761, with only 154 in 5+ unit multi-family structures.    So, building permits were cut by more than half in just a year.  In Floyd County, building permits increased from 248 to 260, with multi-family units driving the increase from 2021 to 2022.

The Fed may be approaching the last rate increase at its next meeting in May.  There is an outside chance that there will be a pause, but an increase of 25 basis points is likely.    The rate of inflation growth is falling, with the last CPI headline number running at 5%.    After the pause in rates, the Fed will hold for some time, keeping mortgage rates elevated.    Some participants are pricing Fed rate declines later this year, but that is not certain.    As the economy slows, this will push interest rates down, bringing further relief to mortgage rates.

submitted by
Uric Dufrene, Ph.D., Interim Executive Vice Chancellor for Academic Affairs, Sanders Chair in Business, Indiana University Southeast

The past two weeks saw some key data releases, and the trend pointed in the direction of a slowing economy.  This is getting us closer to a Fed rate pause, the first step in a reversal of rate hikes.

The national payroll report on Friday showed the economy adding 236,000 jobs in March.   The 236,000 number was in line with expectations, coming in just under the consensus estimate of 240,000.   The more revealing number was with private payrolls, slowing to 189,000. This is the smallest positive gain in private payrolls since early 2020.    The data released showed that the average work week declined to 34.4 hours, from 34.5 the previous month.

One big positive with the report was the jump in the labor force.  The nation’s labor force climbed almost 500,000 from the previous month, and the labor force participation rate increased to 62.6%.  An expanding labor force will help apply headwinds to average hourly wages.  The report did show that average hourly earnings increased by 4.2% on the year, and this was slightly less than expected. This is a number the Fed will closely monitor. A deceleration in average hourly earnings will give the Fed some of the justification it needs to pause interest rate hikes.

National manufacturing continues to point to a slowing economy. The payrolls report showed that manufacturing lost 1,000 jobs nationally, and the latest ISM report showed additional deceleration.  The ISM Index slowed to 46.3, down from 47.7 the previous month.  A number under 50 points to contraction, and above 50 points to expansion in manufacturing. The ISM Index hit 50 back in October 2022, and has been in negative territory since.  A reading of 46.3 is not necessarily consistent with a recession, however.  There have been readings in that vicinity absent a declared recession. But if the declining trend continues, this will no doubt put us closer to the start of a recession.

We have been expecting a slowdown on the goods side of the economy for quite some time.   The nation saw a surge in goods spending during the pandemic and the year following.    At some point, we need to see a slowing of goods spending, and that is exactly what has occurred. While we have been expecting slower growth in goods spending, spending on services has been increasing.  The ISM Services Index showed a big surprise, however.   The index came in at 51.2, much lower than the consensus estimate of 54.5, and a noticeable decline from 55.1 the prior month.  The services economy is still expanding, but the last report showed that the service economy may be reaching a stall, in line with the overall slowing of the economy.

A couple of other labor market reports point to slower growth. Unemployment claims, which have been running consistently under 200,000 for the week, surged to 228,000.   This level is still significantly under the number that is associated with a recession, but the gain was noticeable. If we begin seeing unemployment claims increases like the one last week, this will be noticed by the Fed and more calls for a rate pause and ultimately reversal will become more pronounced. The JOLTS report showed that job openings fell to under 10 million.  While this is still a very large number, relative to unemployment, the decline reversed the past couple of months that had seen job openings increase.

The other big piece of information over the past two weeks was on the inflation front. The Fed’s preferred inflation gauge, the PCE Deflator, came in less than expected.  The Core PCE Deflator, which excludes food and energy, increased by .3%, and this was less than the expected change of .4%.   The year-over-year change was 5%, less than the expected change of 5.1%.  The stock market responded favorably.   The 10-year Treasury yield peaked at 4.2% in November 2022, and has declined to 3.4% since.  A declining Treasury yield signals slower growth and a declining premium for inflation.

Markets are still expecting a rate hike of 25 basis points for the next Fed meeting in May.  We may see a pause if additional economic reports come in weaker than expected.  We are not quite there yet, but it will not surprise me if we see a pause in rate hikes come May.

submitted by
Uric Dufrene, Ph.D., Interim Executive Vice Chancellor for Academic Affairs, Sanders Chair in Business, Indiana University Southeast

Since the Covid pandemic, it seems that there is never a dull moment when it comes to economics and the financial markets.  We’ve taken quite a few roller coaster rides along the way, and over the past couple of weeks, a new ride was added to the park.

The latest to hit financial markets is the emerging banking crisis, as it has been defined by some. I’m far from a banking expert but will try to summarize the gist of the problem.      Over the past year, the Fed has increased interest rates at the fastest pace since the 1980s.  We saw four consecutive increases of 75 basis points, and the most recent meeting saw another increase of 25 basis points.

One effect of these interest rate increases is the impact on the value of existing bonds. For example, the traditional 60/40 portfolio had a bad year, and this was due to a combination of sinking equity prices, and declining bond values.  Traditionally, when stocks are declining, we might expect to see gains in bonds, due to declining interest rates in anticipation of a slowing economy.  But in the past year, we saw an escalation of interest rates, and this was done to stamp out inflation, which was running at a 4-decade high.   So, in addition to declining stocks, we also saw declining bonds (due to increasing interest rates).

What is the connection to the bank turmoil we’ve been hearing about? Let’s take Silicon Valley Bank and use it as an example.  Silicon Valley Bank (SVB) was very focused on the technology industry, which makes sense with a name like Silicon Valley Bank.  Remember what was happening to the stocks of some of these technology companies during the pandemic?   We were seeing sky-high stock prices, and these companies were generating lots of cash. When you have a lot of cash, you deposit it at the bank. Banks take deposits and lend to businesses and consumers in the form of loans (assets to the bank).   The bank could only lend out money so fast and could not keep up with the amount of cash being deposited in the bank.

So, with all this cash, the bank purchased assets in the form of bonds, Treasury bonds and mortgage bonds backed by government agencies.   When investors seek a safe investment, they typically look to government bonds, and this is what Silicon Valley Bank did.   These investments were safe from a credit risk perspective because of the backing of the U.S. government. Credit risk is one type of risk when you buy a bond, but another type of risk is interest rate risk.  Interest rate risk occurs when a bond value declines due to increasing interest rates.

All these bonds that were purchased by Silicon Valley Bank declined in value due to higher interest rates.   These losses then necessitated the company to announce that it would issue more equity, to basically cushion the losses from the bank’s bond portfolio.   Theory and evidence show that when a company announces an equity offering, stock prices usually decline, and that is what happened to SVB.   The stock price plummeted, and the social media world erupted around the safety of the bank. The bank also had a very high level of uninsured deposits.  Depositors began to panic, and a “new-fashioned” bank run ensued.  I use the term “new-fashioned” because it was a bank run, not like the one you see in It’s a Wonderful Life, but one that came through mobile phones and laptops.

These developments, along with higher interest rates, will curtail investment.  We are already seeing a big slowdown in capital expenditures, compared to the past couple of years. A constrained investment environment will work to also produce an overall slowdown in the economy, which is what we have been expecting for this year. Financial markets are now predicting the Fed will begin to lower rates later this year as a result of the anticipated slowing of the economy. We’ll likely continue to see decelerating inflation, even though the past couple of reports came in a little stronger than expected on some measures.   As we mentioned in our outlook last November, we can still expect a shallow recession, even with the latest ride.

submitted by Uric Dufrene, Ph.D., Interim Executive Vice Chancellor for Academic Affairs, Sanders Chair in Business, Indiana University Southeast

Recent data releases show that Southern Indiana continues to see strong job growth. The most recent county-level data show that payrolls increased by 4,127 during the 3rd quarter of 2022. This is the highest increase since the Covid pandemic, not counting one outsize increase due to the reopening. Since 2001, there has only been one other quarter where the region observed a greater change in jobs, and that was in the fourth quarter of 2015. The five Southern Indiana counties of the Louisville Metro region are now at the highest level of payrolls in history. The region now boasts 112,807 jobs, exceeding the previous 2022 Q2 high of 111,854.

The largest gains occurred in the accommodation and food services industry, adding 1,397 jobs. The significance of this gain is the industry is now at the highest level of jobs in the history of the series. In fact, the industry has added about 1,000 jobs since the 3rd quarter of 2019, just before the pandemic. Average weekly wages are also at the highest level, at $443, and 15% higher than the previous year. Just prior to the pandemic, average weekly wages in food and accommodation were at $316. So, the industry has seen a sizeable increase in wages, increasing by 40% since the 3rd quarter of 2019. This has implications for pricing, profitability, and labor.

Nationally, the services economy is running strong. The latest ISM Services index came in higher than expected, and well over 50, the mark that shows expansion. The latest report was released on Friday, and the equity markets responded with strong gains. This is one of the challenges of the Fed. The service economy is expanding, and bringing wage growth along, as we see with the strong Southern Indiana wage growth in accommodation and food services.

The second leading industry with respect to job growth is admin. & support & waste mgt. & rem. services, adding another 780 jobs. Most of these gains are likely in temporary labor services. Along with the sizeable increase in payrolls, average weekly wages are also at the highest level in the history of the series, at $976. This represents an increase of $123 from the previous year, representing an increase of 14.4%. Since the 3rd quarter of 2019, average weekly wages have increased by 30%.

Another notable increase came in manufacturing, adding almost 600 jobs over the year. Average weekly wages now stand at $1,188, which is the highest for a 3rd quarter result. Overall, average weekly wages peaked at $1,253 for the 4th quarter of 2021. During the 3rd quarter of 2022, the national ISM Manufacturing Index was hovering right at about 50. In fact, it fell below 50 during the 4th quarter of 2022. Despite the deceleration in national manufacturing, manufacturing payrolls across Southern Indiana were accelerating through 2022. We also saw similar trends across the metro area.

One of the reasons why the region continues to see strong job gains is due to growth in the labor force. Unlike labor force trends that we observed nationally over 2022, the Southern Indiana labor force did see positive traction over the year. The latest data show that the Southern Indiana labor force increased just above 4%, whereas national labor force growth just eked out a .01% gain.

Last month saw strong payroll growth nationally. The monthly employment report showed payrolls increasing by a whopping 500,000 plus. Retail sales saw sizeable gains, and inflation measures also ticked up. All this is making things very complicated for the Federal Reserve. One month is not a trend, but if we see another strong payrolls report for February, along with any pick up in wages, this will change the calculus for the Fed. Markets continue to price in another 25 basis points increase for the next meeting in March. This may change if we see stronger employment reports and additional signs for accelerating inflation. We thought peak inflation was in the rear-view window. The next couple of months will be quite telling, and additional data will give us hints on pending Fed action.

Submitted by Uric Dufrene, Ph.D., Interim Executive Vice Chancellor for Academic Affairs, Sanders Chair in Business, Indiana University Southeast

–January U.S. job growth surprises everyone

The BLS released the final monthly report on metropolitan area employment and unemployment and the results show strong job growth for the metro region. Louisville gained approximately 21,000 jobs over 2022, and this represents a 3% change over the year and is the highest percent change for all metro areas in Kentucky. As a comparison, Indiana saw a 1.6% change in payrolls over the year, and Kentucky observed a 2.3% change in jobs. The metro area unemployment rate declined to 2.7%, compared to 3.3% last year, and down from the November rate of 3.1%.

The nation’s economy continues to see challenges with the growth of the labor force and the availability of workers. While Louisville did see an overall increase in the labor force of about 5,000, this is sluggish compared to historical changes. The tightness of the local labor market can be seen by the number of unemployed in the metro region, about 18,000. This is compared to 23,000 unemployed last year. So, the labor force saw a small increase over the year, and the number of unemployed declined. Even though the overall economy is slowing down, the labor market remains tight. The number of unemployed in the region, relative to the size of the labor force, is the lowest in the past 30 years, and perhaps in the history of the series. Nationally, job openings increased last month by about 700,000, taking the total openings back up to 11 million. The openings-to-unemployed ratio is back up to about 2. Unemployment claims also remain at very low numbers, with the latest falling close to 180,000.

This year marks perhaps the greatest consensus for a recession. Certain indicators point to a slowdown and bond market indicators like the inverted yield curve suggest slower growth or a recession. Slower growth and softer price pressures, as evidenced by a decelerating Consumer Price Index (CPI), PCE (Personal Consumption Expenditures) Deflator, and ECI (Employment Cost Index) brought the Fed to smaller increases in the Fed Funds rate by only 25 basis points. This marks a decline from the previous meeting of 50 basis points, and 75 basis points through 2022.

If there is slower growth in the cards, this was not obvious in the last national payrolls report. The BLS released the first Friday of the month payrolls report and it showed a whopping 517,000 jobs were added in the month of January. The U.S. unemployment rate declined to 3.4%, and both the labor force and labor force participation rate saw gains. A key piece of information in the report was the change in average hourly earnings, which declined to 4.4% for the year, from 4.8% the prior month. The combination of payroll growth and decelerating hourly earnings is a goldilocks scenario for The Fed.

While this was a very strong payrolls report, other indicators on the economy continue to point to an overall slowdown. That slowdown scenario was pushed back with the last jobs report, perhaps until next year. That kind of payroll growth, along with historic low unemployment rates, is not the number we see with a recession. Prior to last Friday’s jobs report, there was a chance of a pause in Fed interest rate increases. That is just about out the window now. We can expect another quarter point increase at the next FOMC meeting, and then perhaps a

pause. Upcoming reports on inflation will have to show additional deceleration from the last few months to change the market’s perception of prospective rate increases. The next few months of data will be telling.

By Dr. Uric Dufrene, Sanders Chair in Business Professor of Finance, Indiana University Southeast

The latest county-level payroll data are out, and it shows impressive job gains for Southern Indiana. For the second quarter of 2022, the five counties of Southern Indiana gained almost 4,000 (3,826) jobs from the previous year.   This is the largest gain since the 2^nd quarter of 2021.  If we remove the outsized gains from the Covid recovery year of 2021, the latest gain would be the largest since the first quarter of 2016.   The region also showed the highest level of jobs in the history of the series, with almost 112,000 payrolls across the five counties.   The previous high occurred in the 4^th quarter of 2019, with a little more than 110,000 jobs.   Average weekly wages increased by $71 from the previous year, rising to $928 for the 2^nd quarter.  This represents the highest average weekly wages for a 2^nd quarter time period.

Hospitality led the gains with accommodation and food services adding 1,310 jobs. The second highest change came in administrative and support and waste management, adding 853 payrolls.  This is likely due to the hiring of temporary labor services. Manufacturing also showed growth with another 729 jobs added over the year.

Nationally, the most recent unemployment claims showed a decrease from the previous week and came in substantially under the consensus expected. While the technology sector continues to report layoffs, primarily due to excessive hiring in prior years, overall layoffs remain at historic low levels. One of the reasons, but not the only reason, why the economy is now inching toward a soft landing (which could also include a mild recession) is due to the labor market situation. Claims need to be closer to 350,000 before we get close to a declared recession.

While we are not seeing a slowing economy through the eyes of the labor market, other signs continue to point to a slower economy in the year ahead. The ISM manufacturing indicator is now under 50, signaling contraction in manufacturing.  The ISM services indicator also dropped below 50, pointing to contraction in the services economy, and this decline came as a big surprise.

One is on the inflation front.  The latest CPI (Consumer Price Index) showed a decline from the previous month, and the PPI (Producer Price Index) sank month over month, declining by .5%. The 10-Treasury year yield has retreated from last year’s high of 4.2%, and the latest reading was 3.5%.  A  declining 10-year yield is not a sign of strong growth ahead, but declining yields will bring mortgage rates down, and this will be a boost to the troubled housing sector. The yield curve remains inverted, which means that shorter-term Treasury yields, such as the 2-year yield are higher than the 10-year.  An inverted yield curve developed in advance of the past 6 recessions.  The question is whether this time is different.

Adding to the slowing growth argument, retail sales declined by over 1% for December.  This decline was larger than expected, and the equity markets took this as an indicator of a slowing economy. Over several columns, however, we made the case that retail sales had to come down. The nation’s economy saw a surge in goods spending, and this was made possible through government stimulus and a large part of the service economy that had been restricted.   So, this decline was not altogether unexpected.

We are moving past the “bad news is good news” effect.  With the Fed now moving toward smaller increases in interest rates, bad news will be just that:  bad news. Weak economic reports will signal slowing growth, and the equity markets will respond accordingly.  That said, evolving financial conditions are pointing to more of a “soft landing”, and at worst, we may see a mild recession.

By Dr. Uric Dufrene, Sanders Chair in Business Professor of Finance, Indiana University Southeast

Last Friday’s employment release was described by some as a “Goldilocks” report, and there were indeed several aspects to be excited about.  The equity markets showed approval and the Dow surged by almost 700 points.

First, the nation added another 223,000 in December. While this is still above what would be considered  “normal” expansion, payrolls showed another deceleration from the previous month.   Payroll growth is certainly declining, with the past six months showing deceleration, and the December gain was the lowest in two years.   More jobs were gained in the service sector, outpacing goods job growth by 180,000 to 40,000.

In addition to payrolls expansion, there were two other significant highlights. First, the labor force expanded by 439,000, the largest increase since August.   Gains in the labor force also occurred with solid employment gains, increasing by 714,000. An expanding labor force, along with a surge in employment, combined to reduce the unemployment rate to 3.5%.

The second piece of the report with market significance was the increase in average hourly earnings. Hourly earnings only increased by 9 cents, and this was below market estimates.   The cooling in average hourly earnings is what the market was really responding to with the surge in the Dow, S&P, and the NASDAQ.  Cooling wages is music to the Fed’s ears, and the employment report provided further evidence to market participants that 2023 will result in a less hawkish Fed.

Softening wage growth coincides with data showing that prices also continue to cool.   The last Consumer Price Index (CPI) showed annual inflation declining to a little more than 7%.    This is down from a peak of 9% back in June.  The core rate (CPI less food and fuel) is just under 6%.   To be sure, there is still room for price declines with the Fed’s preferred inflation rate at 2% annual rate.    The battle shaping up this year is between the Fed and financial markets.   Fed speakers continue to display hawkishness, advocating for additional rate increases.   The financial markets continue to price in declining rates, however.  The 10-year Treasury Yield has declined to 3.5%, down from 2022’s peak of 4.2%.    Market pricing of inflation, five years out, has declined from 2022’s peak of 3.5% down to a little more than 2%.

As we pointed out in a column back in August, data continue to point to past peak inflation.   We will continue to see price declines, and the CPI will decelerate further once housing price changes begin to take effect. Home prices are a significant component of the overall CPI, but there is a lag between actual home prices and the impact on CPI.  As softening home prices take effect on the CPI, we will likely see effects on CPI reductions.   This will then lead to rising dove voices among the Fed.

We have one month to go for metropolitan data, but it appears that Louisville Metro will have one of the best years of payroll expansion in over 30 years. Louisville is on track to gain about 30,000 jobs over the year.  Not counting the abnormal changes in 2021, this would be the highest gain on record in 30 years, and perhaps in the history of the series. Our 2022 outlook called for solid payroll gains in Louisville Metro and the record certainly points to that.

In addition to prices beginning to moderate, other signs of the economy slowing down are emerging.  The ISM manufacturing index is under 50 which means that the manufacturing sector is contracting. The big news, however, came on the services side.  The ISM services index also fell under 50.   This was the first time under 50 since April 2020, the depths of the pandemic effects on the economy.

Despite the slowdown, the labor market continues to show resilience.   Unemployment claims declined last week and are significantly under a level consistent with any recession.  Monthly payroll gains continue to run strong, and equity markets are not pricing any deep recession. In sum, the data are shaping up in such a way that a soft landing, while not necessarily ruling out a recession, maybe the eventual outcome.

Almost any article about the economy mentions the pending recession of 2023.   Some are describing 2023 as perhaps the most anticipated economic recession in history.   Despite these recession calls, the labor market remains as strong as ever.

After four consecutive increases of 75 basis points in the Fed Funds rate for the Federal Reserve, the economy continues to show labor market tightness.  The unemployment rate remains at 3.7%, one of the lowest on record. Southern Indiana’s unemployment rate is 2.5%.  Abnormally large job changes continue to show up in the monthly payrolls report, with the last report showing a gain of 263,000 jobs. Louisville Metro employment is on track to have one of its best years of job growth in the past 30, not counting the abnormal Covid-related changes of 2021.  Unemployment claims continue to run at historically low levels.  Despite some small gains in weekly claims, levels continue to fall significantly under 250,000 a week, significantly under the recession marker of 350,000 claims. The latest report shows openings of more than 10 million jobs, almost double the number of unemployed.

If a recession is to occur in 2023, we would need to observe a halt or reversal from current labor market conditions.  Monthly job changes would have to go from strongly positive to negative.  The unemployment rate would need to increase,  to perhaps over 5%, and we would also see a noticeable decline in job openings, with the number of unemployed exceeding job openings.

Another possibility is a recession, but without a significant reduction in jobs.  Some have referred to this scenario as a “jobful recession.”    The economy could enter a weaker period, but without the normal disruptions we typically observe with recessions. In my view, this is the most likely scenario.   The economy will enter slower growth, and this could be officially declared as a recession, but we are not going to see significant disruptions in the labor market.  There will be pockets of higher unemployment in certain industries, but overall conditions will remain relatively sound.

So why will there be an expected recession, with relatively fewer job losses than prior recessions?  Think about the mathematics of gross domestic product (GDP), and a process that I will refer to as normalization.  Gross domestic product consists of consumer spending, investment, government spending, and net exports (exports minus imports). The pandemic brought massive government stimulus that produced abnormal consumer and household behavior, such as selling a home in a day, or waiting 6 months for a simple refrigerator purchase.

This abnormal activity was made possible by government stimulus.  The shutdowns allowed households to amass savings, and stimulus only added to these savings.  This then produced a rise in goods spending never previously observed.  This massive surge produced all the supply chain challenges we all have come to learn about, along with the inflation that is subsiding. A CPI report is out today, and we’ll get the latest.

The economy is now in the process of entering a “normalization” phase.   That means that consumer spending will resume to levels that are more consistent with personal income, earned through wages. Given that consumer spending is the largest component of GDP, this will provide headwinds to overall growth. We will also see similar dynamics with business investment. A strong dollar will support import spending, and this will also serve as a drag on GDP.  So, normalization in the economy will lead to slower growth, with a recession being possible.  All this will occur with a labor market that does not experience severe adverse disruptions. We will likely see increases in the unemployment rate, but nothing close to the 10% range of the Great Recession.  Monthly job gains will decline, but there will be very few months with job losses.  The moderating monthly job gains will be part of the normalization process.