US Economic Conundrum: Will Rising Interest Rates Affect Spending or the Job Market First?

It is a classic economic puzzle akin to the chicken-and-egg dilemma: as interest rates reach their highest levels in over two decades, which vital component of the economy will give way first—spending or employment?

When consumers tighten their purse strings, businesses experience a drop in revenue, and this, in turn, can lead to layoffs as profits dwindle. Conversely, when companies reduce their workforce, individuals find themselves with less money to spend. It is a delicate dance, and the intricacies of this relationship remain a subject of much debate among economists.

For now, it appears that spending remains robust, and businesses continue their hiring spree. The key question is why? Some contend that the robust job market is driving consumer spending, while others argue that strong consumer demand enables employers to maintain a solid hiring pace.

Consumer spending plays a pivotal role in the US economic landscape, contributing to approximately 70% of the nation's economic output. Consequently, it acts as a litmus test for the overall health and trajectory of the American economy.

Determining which will weaken first—spending or hiring—entails consideration of various nuances. Factors such as the lingering effects of pandemic-era savings, varying degrees of pent-up demand for specific goods and services, and the ever-evolving economic landscape across different business cycles all come into play.

Although the US labour market's meteoric rise in 2021 and 2022 has slowed, it remains robust. In recent months, it has exhibited signs of cooling, as underscored by the latest jobs report released on a recent Friday.

The report indicated the addition of 150,000 jobs in the previous month, slightly below expectations but still a notable increase in employment opportunities. While October's job growth may have lagged behind the previous month's performance, it comfortably exceeded the minimum job gain required to match population growth—estimated to be between 70,000 and 100,000. Unemployment rates remain low, and job vacancies are at historically high levels.

A moderation in the labour market's growth trajectory can result in income deceleration and diminished consumer confidence in their employment prospects. This tends to affect consumer spending and may ultimately lead to layoffs.
However, a counter argument posits that there have been instances in which spending faltered before the job market.

A prime example is the housing market crash of 2008, which precipitated the Great Recession and, in turn, led to a slump in consumer spending.

The performance of the EURUSD pair has been notably intriguing in recent days. The euro has made significant gains against the US dollar, with a notable surge occurring during Friday's trading session.

As interest rates continue to shape the economic landscape, the outcome of the spending versus employment dilemma remains an issue that economists, policymakers, and market participants will closely monitor.