For years, inflation has been the primary threat to the American economy. However, a new challenge is now emerging: unemployment.
While inflation continues to cool, warning signs are appearing in the job market, which remains strong. The Federal Reserve must now consider the possibility that maintaining high interest rates for too long could be a mistake.
Some economists are urging the Fed to ease its efforts to combat inflation before the high interest rates, which were intended to control rising prices, push the US economy into a recession.
“It’s time to cut rates,” said Joe Brusuelas, chief economist at RSM. “Inflation is no longer the main concern. The balance of risks is shifting towards higher unemployment.”
Mark Zandi, chief economist at Moody’s Analytics, noted that the labor market is being strained by high borrowing costs.
“The biggest danger is a policy mistake: The Fed keeps rates too high for too long,” Zandi told CNN. “The Fed is signaling a rate cut in September, which is fine, but any delay beyond that could be excessive.”
Even Fed Chair Jerome Powell acknowledges a significant shift in risk.
“Elevated inflation is not the only risk we face,” Powell told lawmakers, pointing to easing inflation and a cooling labor market.
The Labor Market May Be Turning
The job market is not collapsing, but signs of strain are emerging.
The unemployment rate, though still historically low, has risen for three consecutive months—indicating a possible shift in the labor market, according to KPMG economists.
Hiring has slowed in sectors like leisure and hospitality, driven by consumer spending. The rate of workers quitting their jobs and the rate of new hires have both declined.
Powell highlighted these changes, noting that recent indicators show the labor market has cooled significantly from two years ago.
“This is no longer an overheated economy,” Powell said.
This cooling is what the Fed intended with its rate hikes, aiming to prevent a hot job market from exacerbating inflation.
However, the current risk is that the Fed’s inflation-fighting measures could cool the job market too much, leading to job losses.
In June, the job market added 206,000 positions, reflecting a balanced state, according to the latest government figures.
“A balanced labor market with overly restrictive Fed rates won’t stay balanced for long,” Brusuelas said. “That means higher unemployment.”
He clarified that this doesn’t necessarily mean “skyrocketing” unemployment but could lead to a premature recession if the Fed delays cutting rates.
In a recent report, KPMG’s senior economist Ken Kim noted that the unemployment rate is nearing a threshold that signals the start of a recession. The services sector, a key growth engine for the US economy, is showing signs of weakness.
“Inflation is no longer the predominant concern,” Kim wrote. “The potential for a sharper deterioration in the labor market and economic activity is equally worrisome. A soft landing is the goal, but a hard landing is emerging as a risk.”
Inflation Isn't Gone
The high cost of living remains a concern. Although inflation has slowed from 9% in June 2022, Americans are still paying significantly more for groceries, rent, and insurance than before the pandemic.
There are still inflation risks, such as potential disruptions from conflicts in the Middle East and the Russia-Ukraine war. The upcoming US election also adds uncertainty.
Some economists worry that former President Donald Trump’s economic policies could reignite inflation. Additionally, cutting rates before the election could politicize the Fed’s actions.
Learning from the Past
If the Fed cuts rates too soon, it could boost consumer and business demand, potentially reigniting inflation.
Powell and his colleagues face a difficult decision, wanting to avoid past mistakes. In the 1970s, the Fed prematurely cut rates, causing inflation to surge back, necessitating more drastic measures. More recently, the Powell-led Fed was slow to respond to rising prices, assuming inflation was temporary.
“They have PTSD from past mistakes,” said Zandi. “They delayed raising rates before, and now they risk keeping them too high for too long.
