Former Fed adviser hopeful an upcoming recession is 'not in the cards'

Andrew Levin, Former Federal Reserve Board Special Adviser and Dartmouth College Economics Professor, joins Yahoo Finance Live to discuss the Federal Reserve's January interest rate hike, the trajectory of the federal funds rate, wage inflation, and the odds of recession in the next year.

Video Transcript

DAVE BRIGGS: Check in now with former Federal Reserve Board special advisor and Dartmouth College economics professor Andrew Levin. Nice to see you, sir. So we'll give you a blank slate there. Your reaction to the expected 25-point hike and the language ongoing increases. What are your thoughts?

ANDREW LEVIN: Well, I think that there were a few minor updates to the statement that they issued at 2 o'clock. The quarter-point hike was no surprise at all.

So the real challenge here is for Chair Powell in a few minutes to explain more about their thinking. There has been a lot of economic news in the last few weeks, so it's really important for him to give an update how their thinking is evolving since the last time they met in December.

Remember, four times a year the Fed issues a fresh set of economic projections, but this is not one of those four times. So it puts more-- a little bit more weight on the remarks that he's going to make.

SEANA SMITH: Well, Andrew, how has your thinking evolved since the last time we spoke? Because when we spoke then, you were saying 6% to 7% for the fed funds rate, that wasn't out of the question. Has that changed since we have gotten some economic data that has shown that the economy has eased a bit?

ANDREW LEVIN: I think that there has been some good news, and so I try to keep an open mind here not to get stuck in a rut. I think the good news is that some of the measures of inflation and even the latest measure we got yesterday on the employment cost index looks-- there's some sign that nominal wage growth might be starting to edge down. I think we need to wait several more months to see some of our employment reports to get a clear handle on it.

It's complicated because there's a lot of different kinds of workers, and the workers who are coming back into the workforce-- we saw it this morning in the latest-- it's called the JOLTS report. Still a lot of workers quitting their jobs, moving to a different job, probably because they want a cost-of-living increase and they couldn't get it from their previous employer.

So the challenge for the Fed is that if workers continue to want to get cost-of-living increases for the big cost-of-living increases they've faced in the last couple years, firms are under pressure in a strong labor market to do that. Firms got to pass those costs on to-- into their prices. Then we see kind of inflation getting entrenched.

And so I wouldn't rule out the possibility that the Fed still needs to raise further, but I think probably the latest data gives them some breathing room. Maybe they'll make one more quarter-point hike in March, and then maybe they can wait a few months to sort of see is the service-price inflation coming down the way they've been hoping, or is it staying too high and that they need to tighten a bit further to really make sure that inflation comes back to earth?

DAVE BRIGGS: So we're about 10 minutes away from the most measured speech since Tom Brady's retirement this morning. What are you listening for, Andrew?

ANDREW LEVIN: Well, I think that some investors have been really worried about the risk of a recession. The latest consumer data we got for December doesn't look so great. The distinction of is the economy just flattening out, kind of taking a pause but it's going to pick up speed again or does it look like it's teetering on the edge?

And so I'm sure that Chair Powell is going to get questions about this today, kind of what the Fed officials see as the risk that the economy is going to slide into recession and how is that influencing their policy plans. Those are going to be really important questions for him to address.

DAVE BRIGGS: What do you think about the likelihood of a recession in '23?

ANDREW LEVIN: I'm hopeful that that's not in the cards. The disposable income has actually been pretty strong, and that's, of course, helped. As workers get cost-of-living increases, gives them some buffer.

Another good news about the inflation that we saw in some, you know, parts of the economy has definitely subsided, and the rent prices are starting to show some signs of slowing down. So consumers get some breathing room on the cost of living. Then that means that the income increases they get will go further.

So hopefully people call it a smooth landing. I was a little bit skeptical about that a few months ago. I think there is some more positive signs.

So one good case for the Fed is smooth landing and inflation continues coming down and the workers have enough cost-of-living increases that wage costs start to flatten out. Bad cases for the Fed, which are still possible, is the economy slows a lot but workers are still getting hefty cost-of-living increases and inflation's still stubbornly high. Then the Fed has to make some tough decisions.

SEANA SMITH: Yeah, Andrew, let's talk a little bit more about the labor market and the dynamics at play there because I think everyone's been scratching their heads trying to figure out the fact that it has been so resilient, what that signals in terms of what's ahead, if it, in fact, will ever break. And some Fed officials have voiced concern that prices could potentially reaccelerate because the labor market is so tight. How valid do you think those concerns are at this point in the economic cycle?

ANDREW LEVIN: OK, these are really great questions. And again, we'll look to Jerry Powell to see what he's thinking. But what I would say is, first of all, we look at the weekly jobless-claim numbers coming in week by week, and those are still very, very low. So there's a lot of headlines about a few high-tech firms that are laying off workers, but for most in the economy, particularly in the service sector, they're desperate to hire. And, in fact, this morning's report, the job openings went back up again.

So a key distinction here in the economy is residential construction is lousy. The housing sector got hit really hard by the increase in mortgage rates. Manufacturing sector is facing some challenges. The service sector, they're looking for more workers, and that's where they need to give cost-of-living increases, and that's where the labor costs are a big part of the prices that those firms charge.

So I would say that the labor market's strong. It's not overheated, and that's an important distinction. It means the Fed doesn't necessarily have to hit the brakes. If the cost-of-living increases can slow down a little bit as workers are catching up, then maybe this will all work out fine. The harder-- much harder situation is the one where inflation's still running two or three times the Fed's target, the Fed may have to do more.

DAVE BRIGGS: To your point, these layoffs have mainly been isolated to the tech sector. We got some more news today out of the automobile sector. Other than Hasbro and 3M and maybe a handful of names, it has been where that's really just 2% of our workforce. Do you think they will begin to spread in the months ahead to the economy as a whole?

ANDREW LEVIN: Again I hope not. I will point out that Walmart, which is a huge employer, just announced a few days ago really big cost-of-living increases, which I think it's great. The people who work at Walmart deserve to get a decent pay.

But those pay increases are on the order of 10%, 15%, and 20% for these hourly workers who, you know, used to get paid $12. Now they're going to get $14 an hour. Still, these are not greedy workers here. They're just getting a fair pay, OK?

But the point is Walmart is a sign of the service sector of the economy. The hospital workers-- there's a lot of other workers who have had really big cost increases, their cost of living. They have to tighten their belts. And those workers should be able to get cost-of-living increases. That creates the challenges that we're talking about with these wage-price dynamics.

SEANA SMITH: Andrew, what is your read on the consumer? Because retail sales, they pulled back over the last couple of reports that we've gotten, down three of the last four reports. We've gotten some data out from Citi this morning of their credit-card data showing that overall spending is at its weakest point that it's been since April 2020. How big of a-- I guess how material of a pullback are you seeing in the consumer data and what that signals?

ANDREW LEVIN: Well, one of the challenges with this data is in normal times when the economy is kind of humming along, we see normal seasonal patterns. So usually in the past, you know, the consumer spending was very strong in November and early December in the lead up to the holidays. I think part of what happened last fall, for a number of different reasons, was a lot of that consumer spending happened in October and early November.

Another shift that's been happening lately is people spending less on goods and more on services. So these things make the data more complex to read and more complex to interpret.

As I said before, the consumer data definitely has shown some signs of faltering, but with disposable income remains strong, I think there is a reasonable hope that consumer spending will be resilient this year and that we're not-- we're not that close to the edge of a cliff.