In recent months, the US economy has witnessed a slowdown in job growth, a phenomenon that typically raises concerns. However, this time around, the response has been quite different. The markets celebrated this slowdown in job growth, with bond yields falling and equity prices rising. Why the positive reaction? This article will delve into the recent employment reports and the underlying factors that suggest the US economy might be headed towards a soft landing, with implications for Federal Reserve policy, inflation, and economic growth.

The Recent Employment Reports

The US government releases two key reports on the job market, one based on a survey of establishments and the other based on a survey of households. The establishment survey found that, in October, 150,000 jobs were created, marking the slowest job growth since June. Notably, the October report included a 33,000 decline in automotive employment due to a strike at the time of the survey. Adjusting for this decline, the underlying employment growth was likely over 180,000, but the slowdown aligns with the view that economic growth will decelerate in the fourth quarter.

The biggest job gains occurred in the health care and social assistance sectors, as well as government employment, accounting for 85% of the job growth. Meanwhile, the non-health care private sector saw minimal job growth, and the manufacturing sector reported a loss of jobs, primarily due to the automotive strike. Construction employment increased by 23,000, primarily due to residential contractors. Wage inflation continued to recede, with average hourly earnings up 4.1% in October compared to the previous year, the smallest increase in wages since June 2021.

Implications for Federal Reserve Policy

The slowdown in job growth and the reduction in wage pressure have raised the possibility that the Federal Reserve might not need to raise interest rates further and could even consider rate cuts. This suggests that the era of monetary tightening may be coming to an end. While the Fed has left the Federal Funds rate unchanged in its last two meetings, it has signaled a commitment to reducing its balance sheet, which could affect bond yields.

Chair Jerome Powell mentioned that although the labor market remains tight, the gap between supply and demand is narrowing, and strong job creation has been accompanied by an increase in the supply of workers. Labor force participation has increased, and immigration has rebounded. Consequently, wage increases have decelerated. The Fed’s focus on the job market’s impact on inflation could wane as wage inflation recedes.

Bond Yields and Inflation

Bond yields have declined recently, signaling a positive outlook for interest rates and inflation. The major central banks of North America and Europe have indicated that the era of monetary tightening may be over. In addition, inflation has fallen more rapidly than expected, and bond yields have curtailed credit creation. The supply of labor has also risen faster than anticipated, leading to a balanced labor market and reduced wage inflation. The latest data on productivity and unit labor costs further support the case for reduced inflationary pressure.

Productivity increased at its fastest rate in the services sector, while unit labor costs declined in the second quarter, reducing the inflationary impact of wage increases. This scenario sets the stage for a soft landing where inflation decreases while the economy continues to grow healthily.

Challenges and Uncertainties

Despite the recent drop in long-term bond yields, they remain relatively high compared to recent history. Several factors may keep yields relatively elevated. The US government is expected to continue running large deficits, leading to high borrowing. Strong business demand for funds is anticipated as companies invest in supply chain redesign, new technologies, climate change mitigation, and clean energy. Additionally, foreign demand for US bonds may weaken if political dysfunction persists or worsens, potentially impacting the global reserve portfolio allocation.

The recent trends in employment, bond yields, and inflation suggest that the US economy may be on the path to a soft landing. The Federal Reserve’s policy decisions, coupled with increasing labor supply and improved productivity, provide reasons for optimism. While challenges and uncertainties persist, a balanced labor market, reduced wage inflation, and increased productivity bode well for the economy’s future, potentially allowing for a harmonious transition to a period of stable growth with lower inflation.