With Federal Reserve officials raising interest rates at an unprecedented pace over the past year to fight sky-high consumer prices, Wall Street’s top minds have been sounding the alarm about the potential for a recession. In fact, they’ve been doing it for so long that some recession predictions are now more than a year old. The Street fears that if the Fed wants to slow inflation to its 2% target, officials will have to raise rates until a wave of job losses hits the economy. But Goldman Sachs’ economists have consistently remained upbeat amid concerns over the labor market and other economic “storm clouds.” The consensus U.S. recession probability over the next 12 months on Wall Street is roughly 65%, but Goldman’s team has seen the odds at something more like 35%—and it’s doubling down after the release of promising labor market data last week.
A red-hot labor market has helped exacerbate consumer price increases for over a year now, according to Fed officials. As a result, Chair Jerome Powell said in testimony to Congress last month that “some softening of labor market conditions” will be necessary to slow inflation, adding to long-running concerns that officials could spark a recession with aggressive rate hikes. But Powell also maintained there doesn’t have to be a “a sharp or enormous increase in unemployment to get inflation under control,” arguing there’s a pathway to a “soft landing for the economy.”
The latest labor market data looks like just the pathway Powell was describing, Goldman senior U.S. economist David Mericle explained Friday.
“This week brought encouraging news about the prospects for achieving the gentle rebalancing of the labor market needed for a soft landing,” he wrote in a research note, making note specifically of labor supply going up while demand has fallen—all without a subsequent rise in the unemployment rate.
Three reasons for the Fed to celebrate
Mericle and his team of economists outlined three positive trends in recent labor market data that should enable the Fed to control inflation without a serious increase in unemployment or recession.
First, rate hikes have already “painlessly” cut labor demand, they argue, by reducing the number of job openings in the economy without increasing the unemployment rate. This is “a dramatic departure from the usual historical pattern that many thought impossible,” Mericle said.
Job openings fell by 632,000 in February and are down by more than 2 million since their peak of 12 million in March of last year, according to the latest Job Openings and Labor Turnover Survey (JOLTS). Mericle explained that this represents the “largest decline in history outside of a recession,” and has helped moderate “problematic wage pressure” to a level that is compatible with 2% inflation.
Second, Mericle said that “labor supply has now fully recovered” to its pre-pandemic levels. The labor force participation rate for all workers—which measures the percentage of the population that is working or actively looking for work—was back up to 62.6% last month, near its pre-pandemic norm. He also noted that the all-important labor participation rate for prime-age workers, those between ages 24 and 54, rebounded to its January 2020 level of 83.1%. In other words, a lot of people who want jobs in this economy right now have them, and there’s still a lot of job openings, but not the extraordinarily high level that gave rise to the “Great Resignation” narrative.
“The immigrant population has also rebounded quickly enough over the last year and a half to reverse a shortfall in the earlier part of the pandemic,” Mericle added, arguing it’s another factor that will slow the wage pressures that drive inflation. In November 2021, Insider Economy estimated that over 2 million workers were lost owing to declining immigration during the pandemic, at a time when the economy was estimated to be missing 3 million workers amid the “labor shortage.”
Finally, there is evidence that the Fed’s rate hikes have already begun to slow the pace of wage growth, according to Goldman Sachs. Nominal wage growth slowed from its peak of over 6% last year to around 4.5% in February, even as the unemployment rate has dropped close to a record low at 3.5%. And real wage growth, which accounts for inflation, actually decreased 1.3% year over year in February.
“We see this as supportive of our long-standing view that much of the peak wage growth overshoot was driven by a temporary decline in labor supply, temporary policies that discouraged workers from taking jobs, and temporary energy and other price spikes that led to demands for larger than usual cost-of-living adjustments, all of which faded naturally,” Mericle wrote.
With these temporary wage pressures relenting, the economist argued the need for more rate hikes to fight inflation has “lessened,” opening the way for a soft landing.