Many on Wall Street are still guessing what the Federal Reserve's next move will be. The debate between if and when the Fed will cut interest rates rages on as more inflation data is revealed. Morgan Stanley Chief Global Economist Seth Carpenter joins Yahoo Finance to give insight into how investors can use labor market data to help predict what the Fed's next move will be.

Carpenter points out: "Some of the public economists out there had been saying to get inflation down from where it was, you would need a serious recession, 7.5% unemployment. We weren't convinced. We thought it was coming down and here we are. So now the question becomes, what's going to go on with the growth side of the economy? We got a jobs report on Friday. It was actually a little bit stronger than we thought, but the underlying trend if you look back over the past six months, the past year, the past 18 months, downward trend and labor market growth but what's important from our perspective is you're seeing a softening in hiring. You are not seeing a pick-up in firing."

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Editor's note: This article was written by Nicholas Jacobino

Video Transcript

MADISON MILLS: Atlanta Fed President Raphael Bostic saying inflation is on the path toward the Central Bank's 2% goal. And Wall Street is betting the Fed will start cutting rates in March. But our next guest thinks that's just a little too soon.

So joining us now, Morgan Stanley Chief Global Economist Seth Carpenter. And, Seth, thank you for being here and for sticking with us through those segments. I love this quote that you have in your most recent distribution. Note, you say the road to a hard landing runs straight through data that looks like a soft landing. So that tells me that maybe you are just as confused as the rest of us. Help me get some clarity. Where can I look? Where can the market look for clarity about where the macro environment is heading right now?

SETH CARPENTER: I think the labor market data is going to be the first and most important clue there. I think judging from the comments that Raphael Bostic made that you quoted, inflation really is coming down. We were really early cheerleaders that inflation was going to come down without there having to be a recession that forces things down.

Some of the public economists out there had been saying to get inflation down from where it was, you need a serious recession, 7.5% unemployment. We weren't convinced. We thought it was coming down. And here we are. And so now the question becomes, what's going to go on with the growth side of the economy? We got a jobs report on Friday. It was actually a little bit stronger than we thought.

But the underlying trend, if you look back over the past six months, the past year, the past 18 months, downward trend in labor market growth. But what's important from our perspective is you're seeing a softening in hiring. You are not seeing a pickup in firing, even as aggregate demand cools down. And that for us has been why since the beginning of 2022, we've been in this soft landing camp. We feel pretty comfortable there.

For a while, markets were throwing garbage at us, telling us that we were clearly wrong. The Fed can't hike that much without causing a recession. Now here we are. And the market's actually getting a little bit ahead of us now, thinking the Fed's going to start cutting sooner. Labor market data is going to be the first place to look.

JOSH LIPTON: And so I'm interested to follow on that because you said like a lot of people might have disagreed with you, right? I mean, I think if you reran the tape 12 months ago, there were a lot of smart--

SETH CARPENTER: If you have that tape. I'd love to see it.

JOSH LIPTON: I get it right to you, Seth. There was a lot of smart economists, though, 12 months ago, saying recession, we're going to tip into a downturn. You know, I'm just interested why didn't we, Seth? Was it just the economy was more-- it just proved more resilient to that rate hiking campaign than a lot of people thought?

SETH CARPENTER: I think there are a few components to it. The one sort of underlying factor is we did get a lot more support I think over especially over last year from fiscal policy than even we judge, but I think the most people were expecting it. Lasted longer. People look at which year is the deficit to see when that stimulus is going to happen, actually dragged out over more time.

But the real fundamentals for us really come back to the labor market. So we know that when the economy bounced back out of COVID, employment bounced back much more slowly. It didn't bounce back proportionally. And so that means the economy as a whole was kind of shorthanded. And so we've seen businesses up until very, very recently, essentially until now, hiring was for current needs and to backfill those positions. So that's given a little bit of a buoying effect to the economy. So that's one key part to this puzzle.

I think the other part, though, take that same view, what usually causes a slowdown to turn into a recession is businesses starting to fire people, so they see slower sales. They see less demand. And they go, we got to do, we got to cut costs. We're going to fire people.

Turns out when people lose their job, they spend less, and so the economy has less spending. So more layoffs happen, which means less spending, which means more layoffs, and it builds on itself. We're just not seeing that dynamic right now. We're seeing a reduction in hiring. We are not seeing a pickup in firing.