For all pre-pandemic recessions since 1970, the NBER's date for the official start coincided very closely with the month in which the unemployment rate began to rise. That didn't happen in 1H22.


Avoiding an NBER-determined recession entirely will depend on inflation coming down sufficiently over the next year to satisfy the Fed's price stability mandate, while the labor market holds steady. This would entail an outcome that hasn't been common in the past 50 years. Yet as mentioned above and documented in another blog earlier this year, this cycle really is unique, and typical patterns may not apply.


Some differences are evident when you look at economic patterns for seven pre-pandemic NBER recessions. From the official recession start date, each economic variable is evaluated by the number of months that

it peaked/troughed either before or after that date. For example, inflation measures peaked on average within a few months of the start of the recession, and more often much sooner rather than later. By contrast, the labor market continued to get worse for about a year after the average recession began. Meanwhile, the Fed typically stopped hiking rates many months before the recession (10 to 18 for the last three recessions) and was almost always cutting rates before it began.


These cycle-timing dynamics are clearer in Fig. 2, which shows the average path for CPI inflation and the unemployment rate across all seven recessions for the 36 months before and after the recession started. Average inflation rose steadily over the three years leading up to the recession, but then fell rapidly in the year after peaking. The average unemployment rate only started rising once the recession began, then rose continuously for roughly 18 months, with another six months before any improvement. A logical interpretation of these patterns is that rising unemployment is a necessary condition for inflation to fall, an ominous requirement for the current cycle.


This cycle is already unique because the Fed was so late to start hiking, and it may continue to do so after a recession has already begun. Inflation may also have peaked in June before an NBER recession began and absent any labor market deterioration. Falling goods prices and a cooling housing market, among other factors, suggest inflation should moderate over the next year. But whether it will fall enough without at least a 1-percentage-point rise in the unemployment rate is debatable.


While that's typically necessary, current labor market conditions also don't have any precedent. For one, job vacancies have soared over the past two years, and as a percentage of the labor force are far higher than at any time in the last 55 years. Vacancies have always started declining prior to the onset of a recession; companies will eliminate job openings before they start laying off workers. Now with so many job openings, they could decline to the pre-pandemic level without a material increase in the unemployment rate.


Whether that's sufficient to reduce wage growth is also debatable, but the relationship between vacancies and average hourly earnings suggests that it's possible. Since 2010, wage growth has risen steadily with the

vacancy rate, meaning wages go up faster the tighter the labor market, and this relationship has steepened in the past year. The relationship implies that if the vacancy rate declined to its level right before the pandemic began, average hourly earnings growth would fall to about 3.5%, from the current 5.5%. That level of wage growth would be consistent with overall inflation being able to fall back close to 2%.


Another unique aspect of the current labor market is the secular decline in the participation rate. It fell sharply when the pandemic began and has been gradually rising, but is still almost a percentage point below its pre-pandemic level. It's typical for the participation rate to rise during a cycle as the demand for workers and their wages rise. But the secular trend is determined by population dynamics, and the aging population implies a declining participation rate going forward. Other than at the start of the global financial crisis, the secular trend in the participation rate was either rising or at least flat. A secularly declining rate means that companies can't count on an increasing supply of workers due to demographics, which should make them more reluctant to lay off employees, all else equal.


None of these unique labor market factors guarantee that wage growth or inflation can fall without a sizable increase in the unemployment rate, and the latest data doesn't show any decline in labor costs. But these factors do increase the odds relative to prior recessions. This would be part of the Fed's narrow path to a soft landing. We may not have to wait long to find out if this will happen.


Original blog (with charts) - This time is different II, 29 July, 2022.


Main contributors: Jason Draho, Brian Rose, Danny Kessler