Economic Update | On Final Approach for a Soft Landing

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

The economy is now on its final approach for a soft landing. Over the past few weeks, indicators provided key evidence that the nation’s economy will escape both a recession and move past higher inflation. As with all soft landings, it does not mean that we will escape a few bumps (i.e. slower growth next year) as we descend. The forward-looking equity markets also point to this scenario, as evidenced by the almost 10% gain in the Dow since early November.

Several key reports came out that support this soft-landing scenario. The first has to do with inflation itself. The last Consumer Price Index release showed that inflation declined to 3.2%, and the core rate (minus food and energy) declined to 4%. The significance of the report, however, was that it came in below expectations, by just 1/10^th of a point.   The market was expecting a CPI of 3.1%, and the report showed price gains of 3%. On a monthly basis, the CPI showed that inflation was 0%. After the equity markets digested this information, the reaction was overwhelmingly positive, with the Dow increasing by almost 500 points, and the NASDAQ up by over 2% on the day.  The CME Fed Watch Tool now shows a 97% probability of no rate increase at the December Fed FOMC meeting.  The odds currently favor the first rate reduction in May 2024, although it is still less than 50%.  The other piece of inflation data digested by markets was the preferred Fed inflation measure, the PCE Deflator.  It also provided additional evidence that inflation is getting under control, showing price increases of just 3%, moving closer to the 2% Fed target.

While labor markets remain tight, with job openings exceeding the number of unemployed, evidence continues to build that the job market continues to show some softening.  The JOLTS (Job Openings and Labor Turnover Survey) report showed a decline in nationwide job openings to 8.7 million, with the market expecting 9.3 million.  Fewer openings show that the supply and demand of labor continue to move toward a greater balance. Meanwhile, the last employment report (from a survey of establishments) showed the nation gained 199,000 jobs, just over the market consensus.  A portion of this gain was returning UAW strike workers and state and local government showed a big job in payrolls.  The private sector only showed job gains of 150,000, and when you strip away the return of UAW workers, private payrolls came in weaker than in the past.   In the past six months, private payroll gains averaged 129,000, compared to 228,000 in the first half of the year.    

On the plus side, there was a big jump in the nation’s labor force (from the household survey of the employment report), increasing by more than 500,000. This is important for the supply side part of the economy and the headwinds this will place on average hourly earnings, both contributing factors to containing inflation.  More impressive than the gain to the labor force was the increase of more than 750,000 in the number of employed.   Employment increasing faster than labor force growth will push the unemployment rate down, and it did indeed fall by 2/10ths of a point.  That was quite significant. 

When you combine weaker payroll growth and a decline in job openings, a drop in the unemployment rate, and continued deceleration in average hourly earnings, a soft landing gets into view.

One more significant piece of economic data released in the past couple of weeks was on productivity and unit labor costs.  At the start of the pandemic, productivity saw a significant jump as fewer workers maintained or even increased production. This increased output, per unit of labor, led to a spike in labor productivity. Starting around the 3^rd quarter of 2020, productivity bounced back and forth and then in early 2022, began a gradual decline. This was surprising due to the significant increase in capital investments and technologies over 2021, which should have led to an increase in productivity.  Since March of this year, productivity has been on the rebound, and the last report showed another noticeable increase. This is important because productivity results in lower unit labor costs, thus making companies more profitable, and helps to contain inflation.   

So, when we combine economic indicators on inflation, labor markets, and productivity, one can conclude that the economy is on the final approach to a soft landing.