Friday's strong jobs report won't dissuade the Federal Reserve from the view that the labor market remains too hot to be consistent with its 2% inflation target. Over the past six months, the U.S. economy has created an average of 381,000 jobs a month, compared with a pre-pandemic monthly pace of fewer than 200,000.
But given some of the other shifts happening in the economy, adding jobs this fast actually makes a soft landing in the labor market more likely than if growth had already decelerated. It gives the Fed more of a cushion to slow things down without the economy falling apart.
Let's start by thinking about what kind of labor market environment would be consistent with a soft landing. Though this would depend on a host of factors—global events like the war in Ukraine, supply chain issues and labor productivity—monthly job growth of around 175,000 a month and wage growth under 4% would be pretty close to the pre-pandemic trend.
According to the jobs report, year-over-year wage growth was 5.2% in August. So if our framework is correct, achieving a soft landing would require reducing the pace of monthly job growth by around 200,000 and reducing wage growth by around 1.25%.
That's a significant amount of slowing given the recent trend, but if you're a policy maker, you should find it encouraging. It allows a fair amount of room for things to slow before we'd be falling into a recession. And that gives the Fed plenty of time to change course if things take a turn for the worse. It's a better place to be than if job growth had already decelerated a lot but with wage growth staying strong at current levels.
For an analogy, consider the 1990s action movie “Speed.” In the film, there's a bomb on a bus that will explode if the bus drops below 50 miles per hour. If you were a passenger on that bus and the driver needed to tap the brakes for whatever reason, you'd rather be going 85 mph than 55 mph—you'd want that extra margin of breathing room to slow things down without flirting with triggering the bomb. If you were only going 55 mph to start with, there might not be enough margin for error to pull it off.
Right now we have a labor market moving at that theoretical 85 mph. That 381,000 jobs added per month would be an annualized pace of 4.5 million—faster job growth than the U.S. economy has ever sustained in history. It could decelerate by 200,000 per month—arguably the Fed's goal—and we'd still be left with a labor market adding jobs as quickly as we were pre-pandemic. And it would still leave measures of labor utilization like the percentage of prime-age people who are employed at generational highs.
There are, of course, some question marks associated with this scenario. We still need wage growth to slow down as well, and we don't know how that will go. Though we have already begun seeing signs of slowing in some of the industries that were first to see wage growth last year. Wage growth for workers in the leisure and hospitality industry peaked at more than 13% and has already fallen back to 8.6% on a year-over-year basis, and even slower than that on shorter time horizons. We've seen a similar deceleration in wage growth for workers in the transportation and warehousing industry as e-commerce companies no longer struggle with labor shortages like they did last year. While it's not assured, it stands to reason that as labor market conditions slow more broadly we'll see more signs of wage growth abating.
There's also a big question about productivity growth, which has been awful this year and contributed to the mix of high inflation and weak output growth that we've seen. One explanation is that companies have struggled to onboard the millions of workers they've hired over the past year—it takes time for new workers to get up to speed. The hope is that this is just a cohort effect. The U.S. economy has an unusually high percentage of inexperienced workers at the moment, and over time they'll become just as productive as workers have always been.
If so, getting back to pre-pandemic labor market conditions should be enough to achieve a soft landing in the economy. (If something really has fundamentally changed in the labor market then perhaps that wouldn't be enough, and more onerous scenarios need to be considered.)
This is all a story for 2023. For now, labor market momentum remains strong, even after all the increases in interest rates and tightening of financial conditions this year. The Fed clearly has more work to do. But there's plenty of room for the labor market to slow down before worrying about a recession, and no reason to think that a soft landing is an insurmountable task.
Conor Sen is a Bloomberg Opinion columnist. He is founder of Peachtree Creek Investments and may have a stake in the areas he writes about.