Analysis | The Mythical Soft Landing Looks Slightly More Achievable


The snap financial market reaction to Friday’s payrolls data was a classic example of “good news is bad news.” The US produced more jobs than economists had forecast, ratifying the notion that the Federal Reserve would have to keep pushing interest rates higher to curb the highest inflation in four decades. Bond yields initially rose and stock futures fell. But markets quickly rethought that narrative, and rightly so. A deep dive into the data show that an optimistic scenario for labor markets and inflation remains intact.

Consider average hourly earnings, which is part of the Labor Department report that showed 261,000 nonfarm jobs were created in October, above the 193,000 estimate. Although the wage metric rose just slightly more than expected last month — 0.4% from September versus the 0.3% forecast — the overall trajectory when using a three month annualized metric to smooth out month-to-month volatility shows that earnings inflation continues to cool, even without a significant increase in unemployment. That data confirmed the most recent signal from the employment cost index, a higher-quality but less timely gauge of labor market costs. That may help explain why yields on two-year  US Treasury notes reversed their increase and fell and the S&P 500 Index began to rally hard.

Ultimately, central bankers mainly worry about overheated labor markets insofar as they drive wages higher. That prompts companies to raise consumer prices to offset labor costs in a cycle that can theoretically perpetuate inflation, if not drive it higher. Traditionally, central bankers have tackled inflation in part through policies that end up putting people out of work or at least give them less bargaining power with their bosses. And that has led economists and market participants this year to obsess over the Phillips Curve (the relationship between unemployment and inflation) and its distant cousin, the Beveridge Curve (the relationship between job openings and unemployment.) 

With job openings still running at around two for every available worker and payrolls still looking buoyant, many have concluded that both of those metrics need to decline — perhaps meaningfully — for the Fed to tackle inflation. They’re probably right if history is any guide. But if labor market deflation can be achieved without significant job loss, that would clearly be the preferable outcome. And wage pressures do look like they’re resolving themselves to a certain degree, even as those other metrics send the opposite signal.

The knock on average hourly earnings data is that the metric isn’t adjusted for compositional effects, but the trend in moderating wages appears fairly broad-based. Assuming sustainable productivity growth is around 1.5%, wage growth should be around 3.5% in a low and stable inflationary environment. Of 10 major industry groups, four were already seeing wage growth below that pace in the past three months (professional and business services; manufacturing; education and health services; and mining), four are pacing above 5% (construction, leisure and hospitality; information; and other services) and the rest (financial activities; trade) are running around 4%.

There are still plenty of reasons to be worried. If you believe, as economic orthodoxy tells us, that job market tightness today leads to sustainably higher labor costs tomorrow, this employment report still leaves much to be desired from the Fed’s perspective. The unemployment rate at 3.7% is still not far from its five-decade low of 3.5%; Americans continue to leave their jobs at high rates, and often for higher paying ones; and labor demand still looks like it’s meaningfully outstripping supply. Plus, Americans that saw their purchasing power diminish this year may be pushing for catch-up wage increases as they head into a new year. All together, it’s highly conceivable that the moderation of hourly earnings growth will simply stall out at current levels. But at least for now, the positive trend looks like it’s intact, and that gives workers and investors a glimmer of hope that a rosy scenario for inflation could yet play out.More from Bloomberg Opinion:

• What Does Fed’s ‘ Sufficiently Restrictive’ Mean?: Jonathan Levin

• Taming Inflation Is Only Half the Fed’s Battle: Conor Sen

• Your No-Rent-Paying Child Is an Inflation Fighter: Karl Smith

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company’s Miami bureau chief. He is a CFA charterholder.

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