Labour will bolster the US economy in 2024

IN 2024, the eyes of market participants will be focused intently on the Federal Reserve. The two key questions are: when will the central bank cut benchmark interest rates from their highest levels since 2000, and by how much? As much as those questions matter to investors and traders, they are far less relevant for the so-called real economy and its ability to avoid a painful recession.

Why? Because the labour market is the most important cushion against any policy mistakes the Fed might make on the path towards a so-called soft landing. Consider that economists expect the United States Labor Department to say at the end of this week that the unemployment rate held below 4 per cent in December for the 23rd straight month, the longest stretch since the 1960s. And the gains made in the job market are inclusive. The employment rate for prime-age women hit an all-time high of 75 per cent in 2023, and records were also set in terms of employment for workers with disabilities and the labour force participation rate for Black men.

An economy at full employment like now means more hours worked, bigger pay cheques and more Americans covered by healthcare and other benefits. All of those things have been crucial in alleviating the crunch of elevated consumer prices. The wages of most workers, especially those at the bottom, are now rising at a faster pace than inflation. Plus, faster productivity growth should help sustain wage gains above pre-pandemic levels.

This does not mean that the labour market is overheating, which economists worry could support faster inflation. The reality is that the labour market is in much better balance due to more workers joining the workforce. For one, a backlog in processing immigrant work visas that occurred during the height of the pandemic is starting to clear. For another, the labour force participation rate among women is rebounding after dropping due to the strain on caregiving related to the fallout from Covid-19.

It’s little wonder that the American consumer continues to defy the dire forecasts of most economists – though not me. Consumer spending, which accounts for almost two-thirds of the economy, rose 2.7 per cent over the 12 months ended in November even when adjusting for inflation, above the average in the three years before the pandemic. The early readings on holiday spending are encouraging. Although some interest-rate-sensitive sectors such as housing have slowed, they are a much smaller share of the economy.

Moreover, the improved finances of most households since the pandemic began will continue to allow them to weather high borrowing costs. The median inflation-adjusted wealth of families across all demographic and income groups made historic gains from 2019 to 2022, surging 37 per cent thanks in part to fiscal relief programmes enacted by Congress that allowed many families to save and pay down debt. The amount of excess savings, or savings relative to what would have been expected before the pandemic, remains elevated. Customers that had around US$3,000 in bank account balances before the pandemic now have almost US$13,000, according to Bank of America chief executive officer Brian Moynihan. Debt burdens, whether relative to income or wealth, are near historic lows.

Perhaps the real key for whether the economy attains a soft landing is not when the Fed cuts rates, but how fast inflation rates come down. The consumer price index has fallen from its recent peak of 9 per cent in mid-2022 to around 3 per cent. The faster the Fed sees more progress in getting inflation down to its 2 per cent target, the faster it will cut rates. The fact that there are still more Covid-related disruptions in inflation to work out is a buffer from the Fed having to keep rates higher for longer.

The extraordinary pricing power that businesses enjoyed during the pandemic and Russia’s invasion of Ukraine is still unwinding. As then Fed vice-chair Lael Brainard posited last fall, ending the “price-price spiral” could be another way to slow inflation without causing a destruction in demand that would damage the economy. But don’t worry too much about corporate profits. Growth in unit labour costs, while still elevated, has slowed since 2022, and producer prices have started to decline. The normalisation in pricing power alone could get us the last mile of disinflation the Fed wants to see before it cuts rates.

All this is perhaps why, for the first time in two years, most professional forecasters predict we will likely avoid a recession. Don’t forget that the extra gloom that consumers have felt in the last 12 to 18 months has largely been due to the unrelenting narrative that the “bottom will soon fall out” from the economy.

More optimism makes an expectations-driven downward spiral less likely. Already, widely followed measures of consumer sentiment jumped in December, with the one from the University of Michigan surging the most since 2005.

With the substantial progress in bringing down inflation, it’s time to cut interest rates. But even if the Fed delays acting, the many economic buffers in place should ensure that the economic plane lands softly barring some unforeseen bad event.

The writer is the founder of Sahm Consulting and a former Federal Reserve economist. She is the creator of the Sahm rule, a recession indicator.