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Economic Update | State of the Labor Market and the Next Recession

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.

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