Biz con high now – labor market

The global economic outlook has improved significantly since the beginning of the year, for completely different reasons in different regions. The labor market remains particularly strong in the U.S. despite aggressive rate hikes; a mild winter mitigated the impact of the energy shock on Europe; and China managed its sudden abandonment of Zero COVID successfully.

Our last outlook in December 2022 forecasted a recession in the U.S. by the middle of this year. We still expect a recession, but not until the end of the year or the beginning of 2024. The U.S. economy has held up shockingly well in the face of over 500 basis points of rate hikes in just over a year. Part of this is policy driven: the Inflation Reduction Act (IRA), Bipartisan Infrastructure Law and CHIPS and Science Act have fuelled significant manufacturing construction spending after years of underinvestment. Consumption, which accounts for just over two-thirds of U.S. GDP growth, has remained robust thanks to a significant cash cushion among U.S. households and the strength of the labor market. The labor market has remained robust in part owing to labor hoarding—firms are reticent to lay off workers given how difficult recruitment has been since the pandemic. We do not have a good way to measure labor hoarding, therefore there is no easy way to identify inflection points. As corporate profits dwindle in a tighter rate environment, firms might capitulate and let workers go. A sudden deterioration in the labor market is likely to impact consumption even more than the state of household bank accounts, and we expect this will be the trigger for the recession.

There had been concerns that financial instability in March would cause a downturn, but they seem to have mostly blown over so far. Consumer and business confidence have held up well since the banking wobbles. The Federal Reserve’s Senior Loan Officer Opinion Survey (SLOOS) shows that lending standards have tightened since March, but they have been tightening since last year. On the margin, financial instability will weigh mildly on loan extension in the U.S.—but we do not expect a significant credit crunch.

The U.S. labor market has remained very tight, but there are signs it is slowly easing. Wage growth is decelerating and job openings and the quits rate are slowly falling. This suggests the Fed does not need to worry about a wage/price spiral. Nevertheless, inflation has remained stubbornly above the Fed’s target of an average of 2% and the path for the stickiest part of inflation—core services inflation ex-shelter—has been bumpy. The Fed held rates at 5.25% at its meeting in June, but a majority of Federal Open Market Committee (FOMC) officials expect the Fed will hike rates twice more this year. The Fed will base its rate path on the data, but we believe the Fed’s work in leaning against inflation is not done. It will likely hike rates by another 50 basis points in the second half of the year before keeping rates steady through the end of 2023. We expect gradual rate cuts in early 2024 as it becomes clear the U.S. is in recession.