A Recession Suddenly Looks Like It Can Be Avoided

Higher interest rates are no doubt causing pain to investors and consumers, but the economy has been able to handle them better than anyone thought possible six months ago. The worst-case fear was that the Federal Reserve would move too aggressively to correct inflation caused by pandemic distortions in the supply chain, wages and the housing market, and that as those kinks worked themselves out, rising rates would leave the economy crippled by soaring unemployment while inflation was still too high.

Last week’s steady jobs report should now put those fears to rest. The labor market has remained resilient enough to buy time for supply chains to heal and for many of the pandemic-related problems to ease. That’s providing a clearer path for the Fed to target inflation. Should the Fed feel the need to push the economy into recession in 2023, it will be due to an accurate read of structural inflation dynamics rather than data that’s been overly influenced by Covid shutdowns.

Investors began bracing for a recession in June, when the Fed began its series of 0.75% interest rate increases after the shock of May’s elevated Consumer Price Index report. Some saw the bigger hike as an overreaction. The theory was that the housing market was already buckling due to rising mortgage rates and the labor market would soon follow. Meanwhile it could take many months before the inflation data turned down, prompting the Fed to unnecessarily induce a recession because they got head-faked by an economy already in the process of normalizing.

It's now been five months and those fears have not come to pass. The rate at which workers are quitting their jobs has fallen to the lowest level since early 2021 as the “Great Reshuffle” of workers winds down, and wage growth in pandemic-affected industries like leisure and hospitality has decelerated significantly since 2021 as businesses became better staffed. Yet the economy continues to add more jobs than expected each month. In fact, even as layoffs are accelerating, the labor market still remains too strong for the Federal Reserve’s liking.