Now that the impact of the pandemic is fading, the economy is entering more familiar territory. There is, however, still a lot of uncertainty over what the post-pandemic "new normal" will look like.
One area of the economy that has changed since the pandemic is the labor market. In our view, it is difficult to understand what is happening in the labor market without examining trend by age group and gender. The biggest change has been among 16–24-year-old men, where it appears that the strong labor market is drawing people away from colleges. Women aged 25–44 are also working more. This could be related to the decline in birth rates since the start of the pandemic. Employment rates are down for senior workers, which is hardly surprising given the health consequences of the pandemic. We believe that individuals who retired during the pandemic and are currently not working are unlikely to return to the labor force. However, prior to the pandemic, employment rates among seniors was on a long-term uptrend, and we believe that this trend will resume in the future.
Another aspect of the economy that looks very different post-pandemic is inflation. Inflation has slowed considerably from its peak, but it is still unclear what it will take to get inflation back down toward the Fed's 2% target. Wage growth has been rising much faster than in the pre-pandemic period, and over the medium term this is a key determinant of inflation, especially for services. In our view, it is very unlikely that the Fed will be able to sustainably hit its 2% target unless wage growth slows. In recent months, there have been some signs of the labor market softening due to both better supply and weaker demand, but by most measures it still looks very tight.
One other statistic that we are keeping a close eye on is the personal savings rate. Last year, households used some of the excess savings that they built up during the pandemic to help offset higher prices and less income support from the government. However, in recent months, the strength of the labor market has been translating into rising real disposable income, and the savings rate has been trending higher, moving above 5% in March. The savings rate is still below where it was before the pandemic, but going further back, it's higher than it was before the global financial crisis, and 5% could turn out to be within the new-normal range. We would also note that, despite the Fed's rapid rate increases over the past year, the debt service ratio is still low by historical standards. It is therefore possible that household spending will remain firm, helping to keep the economy out of recession, but also making it more difficult for the Fed to bring inflation down. We expect the Fed to hike rates at the FOMC meeting on 3 May. We believe that it is unlikely they will clearly indicate any plan to pause the rate hiking cycle.
Main contributor: Brian Rose, Senior US Economist
Original report – The new normal , 28 April, 2023.
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