Economy is ‘certainly slowing’ amid tightening labor market, economist says

Deutsche Bank Securities Chief US Economist Matthew Luzzetti joins Yahoo Finance Live to discuss the latest jobs data and a cooling labor market ahead of Friday’s March jobs report.

Video Transcript

SEANA SMITH: ADP’s jobs report showing that private employers added 145,000 jobs in March, coming in below what the Street had expected. Joining us now for what this could potentially mean for the economy, for the labor market. We want to bring in Matthew Luzzetti. He’s Deutsche Bank Securities Chief US economist. Matt, it’s good to see you again. So some signs here that maybe the jobs market is starting to cool. How are you looking at the data that we got out over the last two days and what that could signal for Friday’s jobs report?

MATTHEW LUZZETTI: Yeah. I think the data that we’ve seen over the past couple of days and over the past week have really all surprised to the downside. You mentioned ADP this morning. We’ve seen the highest manufacturing and services indices both surprising to the downside. We had the JOLTS data, which shows job openings, which were materially below expectations.

Today, it wasn’t really followed very closely but the BEA has high frequency data on card spending for consumers, which also has slowed materially. So I think we have an economy that very clearly looks like it’s slowing. The labor market, I would say, is still very, very resilient. The uncertainty is how much of this is giveback from very strong data during January and February, which was in part boosted by the weather. But I think at the moment, there’s a lot of uncertainty about that. I think what we do know is the labor market does remain resilient. It does remain tight. But the overall economy is certainly slowing.

SEANA SMITH: And when we talk about the overall economy right now slowing to what extent do you think we’re going to see– could we still see the Fed get inflation under control without triggering a recession? Is that still in the cards?

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MATTHEW LUZZETTI: So on our best case it’s not. We still expect a recession this year. . Ultimately, we’ve always thought it was the second half of the year story our baseline is that it begins in Q4. I think really assessing that the key question has become what happens with credit conditions and bank lending conditions after the recent volatility that we’ve seen?

Certainly that should add to tighter financial conditions. I think it should add to the slowdown in growth that we see over the next several quarters. The key question has been, how much? How much tightening are we going to see? What is the magnitude of the impact on growth? We think at least it could subtract 40 to 50 basis points from growth over the next several quarters, which for us points to a recession risk. That is a bit earlier than our baseline.

SEANA SMITH: Well, Matt, let’s talk about how much more hiking we could potentially see, how much more restrictive policy could get. What’s your base case there? And what do you think could potentially happen even if the Fed is forced to raise rates maybe more than we are forecasting right now?

MATTHEW LUZZETTI: Yeah. Our baseline is that they raise rates again in May by 25 basis points. That would bring the Fed funds rate up to 5.1%. And that’s essentially what they told us two weeks ago as part of their dot plot or projections. But they’ve also told us that they’re highly data dependent. Whether or not they raise rates in May and then beyond will depend first and foremost on what they’re seeing in the data, the labor market and inflation data. We’ll get the jobs report this Friday, which we expect to remain sturdy.

But we’ll get a very important CPI report next week, which will be I think a key determinant for whether or not they raise rates again at the May meeting. And then there’s also this overhang of what’s happening within the banking sector and credit conditions. And do we get any negative evidence there or do we get evidence that is really feeding through into a sharper slowdown in the economic data? So the Fed will be looking at all this. At the moment we expect that they raise rates for the last time in May by 25 basis points.

SEANA SMITH: Matt, what is your assessment just in terms of the turmoil and everything that has been going on within the banking sector? Is the worst of it behind us? Because even Jamie Dimon in his annual letter was saying that the repercussions from the collapse could be for years to come.

MATTHEW LUZZETTI: Yeah. I think over the past few weeks we’ve certainly seen some greater stability. We’ve seen greater calm in the markets. When you look at the Fed’s lending facilities there’s been less take up over the past several weeks.

When you look at bank deposits, they’ve been declining over the past year. But there’s been some stability over there in recent weeks. And so I think we have reached a period where at least for the time being it looks like there’s been greater stability on the banking front.

There’s a related question though is what are the knock on effects to lending conditions that we see over the coming weeks and months and quarters? And that’s where we think that there is going to be a meaningful impact on growth. And that will be banks tightening their standards on commercial and industrial loans to businesses to CRE commercial real estate loans. And that will drive a slowdown in the economy, particularly in the second half of the year.

SEANA SMITH: Matt, what’s your reading just about what’s going on in housing? I mean, that is one area of the economy where we certainly have seen a significant slowdown. Is it going to get even worse or is the worst of the housing pullback behind us?

MATTHEW LUZZETTI: So we think that part, the worst of the pullback is behind us. I mean residential investment has contracted by about 25% annualized in recent quarters, which is a very, very sharp slowdown. And it’s the one area where the Fed’s tightening cycle was transmitted very quickly to the economy through higher mortgage rates, activity in terms of purchases, and then housing starts. We expect that it’s going to contract over the course of this year.

It is typically a cyclical sector, so as the overall economy slows and then moves into contraction you would expect residential investment to be there too, the housing market would be there too. But we do think that to a certain extent the worst is behind us, because we’ve gone through a material construction already. And perhaps we have seen the highs in mortgage rates, which should be at the margin at least helpful.

SEANA SMITH: Matthew, circling all the way back to where we started this segment talking about jobs right now, talking about the labor market. We get the jobs report on Friday. What do you expect that print to be?

MATTHEW LUZZETTI: At the moment we expect to be 250,000 jobs, which is below the three month average below the six month average. So it is slowing. But it’s still an economy that is adding a meaningful amount of jobs. We expect the unemployment rate to be 3.6%.

And if we get that, it’s an economy that still looks tight from a historical perspective. We mentioned the JOLTS data earlier in the week in terms of job openings coming down. Despite that, you still have 4 million more job openings than unemployed individuals. The quits rate has actually moved higher. And so I think the overall messaging from the labor market is certainly it’s one that’s slowing, but it’s still historically tight.

SEANA SMITH: All right. Matthew Luzzetti, always great to get your perspective. Deutsche Bank Chief US economist. Thanks so much for joining.