GDP back on pre-pandemic track, Feds change tone on labor market

Brian Cheung and Rick Newman join Yahoo Finance to discuss the changing optimistic tone over the labor market as the Fed now believes some of the lost workers may never come back due to retirement or childcare and the U.S economy's full recovery.

Video Transcript

MYLES UDLAND: We start this morning with some breaking news on the US economy. GDP data out today, reiterating that the economy grew at an annualized pace of 6.4% in the first quarter. We also got some jobless claims data that showed claims last week totaled 411,000, more than expected, but still indicating some improvement in the labor market.

And joining us now to talk about all of this data and the broader state of the recovery are Yahoo Finance's very own Rick Newman and his senior associate, Brian Cheung. Brian, let's start with you and your latest story on the labor market, and really how the Fed is thinking about the labor market, and concerned that we are not going to see a prompt return to pre-pandemic levels.

And we'll get to Rick story, which is a lot more constructive, in just a minute. But start with the outline that you're hearing from the Fed as they think about the next leg of this recovery.

BRIAN CHEUNG: Yeah, and when we talk about the economy right now, everyone's trying to compare where we are now to where we were pre-pandemic. And when you consider that we're still 7.6 million jobs short of where we were when we headed into the pandemic in February and March of 2020, you realize that there's still a lot of leg work to go.

Now, of course, the question for the Federal Reserve, which has been driving that easy money policy is what's the line going to be for where to get employment before they want to start tightening policy, either by reducing the pace of asset purchases, and/or eventually raising interest rates? And we've heard some commentary from the Federal Reserve lately from the likes of New York Fed President John Williams, and also from Cleveland Fed Loretta Mester that they might not be as optimistic about getting to that labor market as fast as they had originally thought.

We hear Williams, for example, saying that, quote, "Can we get exactly to that economy in a year or two? I'm not sure." And then Mester saying, quote, "I'm not necessarily expecting every indicator to get back to where it was, but I would like to see us get back farther than we've come."

And you don't need to look farther than, for example, the labor force participation rate. If you take a look at that, where we were roughly, in terms of the percentage of the population that was in the labor force, was around 63% in February of 2020. That cratered to quite a low value, kind of close to 60% in the midst of the pandemic. It's since come back, but we've been kind of stagnating around that 61.5% level. And it doesn't show signs that we'll be able to get back to 63%.

Now, of course, what could be behind this? One reason might be retirement. We've heard from the likes of Goldman Sachs say that a 0.5% decrease in the labor force participation rate could be due to retirement or early retirements for people that likely will not be coming back, which means that, guys, this labor market is going to look very different in the post pandemic economy than it did in the pre-pandemic economy.

JULIE HYMAN: Well, and Rick, this is something that you write about as well. But you look at the sort of bigger picture beyond just the labor market and say, you know, we're close to being back at the level where we were.

RICK NEWMAN: Right, so this number we got today from the government, the official number, that's looking back at the first quarter, which ended in March. That's the last estimate for the first quarter.

The forecasting firm IHS Markit measures GDP on a monthly rather than a quarterly basis. And they think we have already exceeded pre-pandemic levels of GDP. In other words, we're back to where we were, and perhaps higher in terms of total economic output. But we have done that with nearly 8 million fewer workers. And if you add up, you know, the job growth we should have had during that time, it's about 10 million fewer workers. So what is going on?

I mean, there is one technical explanation for this, which is that we know consumers shifted heavily away from services over toward purchasing goods during the pandemic. And labor productivity in goods production is higher than it is in services. So that would explain why we could be back to higher levels of output with fewer workers, because the mix has shifted. But it raises a lot of questions about what's going to happen as we try to reabsorb those 8 million, and get back to the pace of job growth we had before the pandemic.

BRIAN SOZZI: Brian, I'm still trying to digest some commentary we saw I believe late yesterday, or yesterday afternoon from the Dallas Fed president Robert Kaplan, suggesting a rate hike-- a rate hike would actually happen in 2022. And I'm surprised that the market hasn't reacted negatively to that. Is that-- does the market need to pay more attention to that type of commentary?

BRIAN CHEUNG: Well, I think just first of all, we have to acknowledge that Dallas Fed president Robert Kaplan has been well known, even before the meeting last Wednesday, to be one of the more hawkish members of the Federal Reserve. Hawkish meeting preferring maybe a reaction function that would be polling or normalizing interest rate policy before his colleagues would. So I think the reason why you've seen markets blink in response to that commentary was because it was mostly expected that he was going to be of that view anyway.

Now, of course, the question is going to be, who are the 13 out of the 18 Federal Reserve policymakers that ultimately penciled in at least one interest rate hike by the end of 2023? There means that there are only five Fed officials-- we know one of them is Neel Kashkari from the Minneapolis Fed-- who have advocated for no interest rate hikes over that time horizon.

Now, of course, we've had at least 10 Fed officials scheduled to speak this week. We did hear from the likes of Raphael Bostic, from the Atlanta Fed yesterday, who also said he has one interest rate hike penciled in in late 2022, with two additional hikes in 2023.

But we're going to hear from the likes of Philadelphia Fed president Patrick Harker. We're also going to hear from the Boston Fed President, Eric Rosengren. And, of course, guys, who knows who's going to be on the docket for next week. So as that flurry of Fed speak comes out, we're going to try to continue to pin which dot is attributed to which Fed policymaker.

RICK NEWMAN: Guys, let me throw one other idea into the mix here. There's some new economic research looking at the work from home phenomenon. And it predicts that before the pandemic only about 5% of workdays were work from home or remote work. This forecast is that, going forward, the new normal is going to be about 20% of workdays from home.

And these researchers found that workers are way more efficient when they work from home, so much so that if this happens, we get up to 20% of workdays from home, this could actually lead to a large increase in labor productivity, which would actually mean higher GDP than we are accustomed to.

Now, this is not-- you don't see this yet in most mainstream forecasts. But it is something to watch for. And if there's something to it, it does support the idea that the Fed will be hiking and tapering sooner than a lot of people think.

BRIAN CHEUNG: Well, and this is exactly the point for the Federal Reserve, which is that the economy is recovering at a much faster clip than they had originally expected, especially when you look at those economic forecasts that were originally put out by the Federal Reserve back in March. You compare that to where we are in terms of their projections as of last week, and they've been sharply upwardly revising that through this recovery.

Now, you bring up an interesting point about productivity. The composition of this labor force in this economy could actually have a positive effect when you talk about the COVID shock rethinking the way that our economy operates in a way that could make it more efficient. If that is the case, productivity is one of those variables that goes into the way that the Federal Reserve thinks about what they call the neutral long term interest rate, or what they call r-star.

Before I get into all the wonky economics, basically the idea is if the economy can be more productive over the longer run, the Federal Reserve would have more room to raise interest rates, which also at some point means they can also lower them in a future downturn, which would be a positive thing for the economy.

Now, of course, whether or not the Federal Reserve can get back into a hiking cycle without encountering some other issue, well, we know that happened in the last hiking cycle before the US-China trade war and then the pandemic ultimately forced the Fed back to near zero. But still a prevailing question for the policymakers down in DC.

MYLES UDLAND: You know, this whole conversation makes me think about how in the before times, when we'd be in the office, myself and Brian would talk about the Fed. And Rick would come over and be like, listen, you nerds, no one cares about the Fed, that you're way too focused on that.

And Rick, I want to think about it this way. If we're outlining a world where GDP growth, which is a number that the common man hears about, I think can understand more readily than Fed funds rate, whatever that nonsense is, how does that change the calculation on the way people think about the economy if we're growing at 4% or 5% over a couple of years?

Because as you know, for the last decade, even when the economy was doing well, everyone thought it stunk, one, because everyone was benchmarked to the financial crisis, and two, GDP growth was still about 2%. Are we entering a completely new world in terms of how voters specifically think about what the US economy means? Because for so long the assumption was, it's bad, and it will never get fixed.

RICK NEWMAN: No, I don't think it's going to be a new world at all for ordinary people. When I write about the economy, it's doing better, it's doing worse, you know what people email and tweet me about the most? Gas prices, and what eggs cost, and what meat costs. I mean, this is what people notice around them.

And more broadly than that, people know if they are getting ahead or falling behind. And it's pretty squishy, because there have been many times-- President Obama had this problem back in I think 2011, 2012. Telling people that the economy's doing really great, and people are looking around like, I don't feel like I'm doing great.

And they punished Obama in two midterm elections. That's when Obama said he got shellacked, because people didn't buy it. So people know when their incomes are going up by more than inflation. And I think it's episodic right now. I think we are there. I mean, we still have the K shaped recovery.

Some people know they've survived the pandemic, and boosted their savings, and they're in good shape coming out. And we still have a lot of others who feel they're falling behind. And that's what policy needs to focus on.

And it's hard. I mean, it's hard to use, whether it's monetary policy or fiscal policy, to help the people who are falling behind feel like they're joining the party.

JULIE HYMAN: Well, Rick, what's interesting about what you're saying is, even if we still have the K shape recovery, prices going up, it affects people who are on the upper swing of the K too. In other words, it affects, you know, whether you are on good financial footing. I think it's safe to say that most people do not like to pay higher prices, and notice those higher prices whether they can afford to pay them or not.

And so you do have to wonder then how that feeds into both sentiment about the economy and then the political implications of that sentiment about the economy.

RICK NEWMAN: I think people higher on the chain, Julie, they're massively benefiting from wealth effects. So yes, some prices are going up, but the value of their homes is up by 20%, 25% during the last year. I mean, that has a distinct wealth effect. And if you're-- at that level, if you're lucky enough to be a homeowner, you probably have some investments too. And, of course, the stock market has done well over the last year.

So I think those people are fine. And it seems to me, as with every presidential administration, the difficulty is reaching and actually helping the people from the middle on down who feel-- those are the ones who feel they're not getting ahead. And that's what we're seeing President Biden and the Democrats trying to do with, you know, the extra jobless aid, the extra stimulus check, and all the stuff they want to do in the forthcoming bills, you know, the child tax credit, and things like that.

That is what they're going for. And I mean, the jury's out. I think so far the Democrats have actually been pretty clever about how they've targeted the aid. It is not really going to wealthier Americans. It is going to middle and lower income people. But we'll see whether those voters think that this has actually helped them coming to the 2022 midterms.

BRIAN SOZZI: Well, Brian, Rick's laying out a case where a more productive workforce, to me, my first thought off of that is, you want inflation? It's not going to be transitory. I mean, you have a more productive workforce, perhaps out there spending more, and perhaps, you know what? Maybe we'll have to see a rate hike in 2022, because we're just going to have to deal-- we're just going to have to deal with structurally higher levels of inflation.

BRIAN CHEUNG: Well, on one hand, I think we need to parse out the two arguments there. And one is that whether or not inflation is going to come from a tighter, more productive labor market, and the Fed's reaction function.

I think when it comes to raising interest rates, look, at the end of the day, the Fed would like to raise interest rates. And that's because they want to have their powder dry for whatever the next crisis might be. You don't want to get only up to 50 or 75 basis points when you go into whatever the next crisis is going to be, because maybe that pushes us into negative interest rate policy. Who knows?

So the Federal Reserve would like to do that. The question is, can they do that without putting a dampening effect on not just the economy at large, but specifically the labor market, which the Fed now wants to more deeply prioritize with their kind of willingness to allow inflation to overshoot moderately its 2% target.

Now, whether or not that's going to happen as a result of a more productive economy I think is a question that won't be answered even in the next three to five years, because productivity is a very difficult thing to measure. But you do raise an interesting point, which is that at some point is there going to be some sort of cost push pressure from inflation that comes from people getting paid more? Wages going up? We haven't necessarily seen that yet, because wage data is still so noisy, because we still have so much compositional differences in the way that we're getting these labor market reports.

But as we continue to get more data over the coming years, it will be interesting to see if that type of inflation that comes from higher wages is, indeed, passing on to the consumer. But I would say, for anyone watching right now, the jury is still very much out on that one. And anyone that says otherwise just simply hasn't seen enough data.

MYLES UDLAND: All right, gentleman, interesting conversation. Rick Newman, Brian Cheung, thanks both for stopping by. As we wrap up the second quarter here, we're just a week away from the next jobs report. So all of this data continues to flow in, and we continue to get updates on, as Brian just outlined, a very fluid and still very uncertain situation on just where the economy goes from here.