Today’s inflation is the result of too much demand chasing too little supply. The labor market is the locus of this imbalance: companies can’t find enough workers. Job vacancies are unusually high. In order to fill these vacancies, companies are having to pay higher wages and recoup the cost from consumers in higher prices.

One year ago, Fed chair Jerome Powell floated the possibility of this process ending in a “soft-landing”. In this scenario, the Fed raises interest rates high enough to slow the economy, reduce vacancies, restrain wage gains, and dampen inflation, but not so high that people lose their jobs. Economists responded with skepticism.

Larry Summers, the former Treasury Secretary, and Olivier Blanchard, the former chief economist of the IMF, wrote last August, “we find it entirely unconvincing as support for the ‘soft landing’ idea...that vacancies can decline substantially taking pressure off inflation without driving unemployment way up.” 

But last week’s data suggests that's exactly what’s happening. The labor market is gently cooling and unfilled openings are falling. Unemployment remains at a 50-year low.

A cooling labor market is evident in other data, too. People are working fewer hours. Wages are growing more slowly. The pay bump for job-switching has almost disappeared.

But until last Friday, there had been a fly in the ointment: the Bureau of Labor Statistics’ nonfarm payroll reports showed companies hiring at a much faster rate than workers were entering the labor force. That’s a sign of an overheating economy with inflation in the pipeline.

Moreover, the payrolls numbers didn’t really make sense in light of the other data. Was the economy cooling as the unemployment rate and other metrics suggest, or running too hot, as payrolls implied?

Friday’s payrolls report showed that companies hired 236,000 workers last month. That’s a sharp slowdown from the red-hot pace of hiring earlier in the year. One swallow does not a summer make, but the data is now telling a more harmonious story.

The labor market imbalance is being resolved from both sides. Fed hikes are slowing the economy and reducing companies’ demand for workers. People on the sidelines are rejoining the workforce. Rising supply is meeting falling demand.

Lower inflation is the ultimate goal; a balanced labor market is just one way to get there. And it seems to be working. Most measures of inflation have declined. Investors’ inflation expectations for the next 5 years are now consistent with the Fed’s 2% target.

To be fair, it’s far too soon to call it ‘mission accomplished’. Monetary policy acts with long and variable lags. The action the Fed has already taken, let alone any further hikes, may ultimately curb inflation but at the cost of a downturn.

Company bosses are downbeat and some worry about a credit crunch after the recent turmoil in the financial sector. Bond markets show that investors expect the Fed to cut rates later this year, presumably in response to an economic slowdown. The Fed’s own forecasts call for recession-skirting 0.4% growth this year.

These expectations are reasonable. Fed hikes are almost always followed by recessions. But the covid-ravaged economy of the past few years is unprecedented. Is this time different?