The Fed’s path to a ‘Goldilocks’ economy just got more complicated

A “help wanted” sign is displayed in the window of a store in Manhattan on December 02, 2022 in New York City.

Spencer Platt | Getty Images

November was not exactly what the Federal Reserve was looking for when it came to jobs reports.

A higher-than-expected payroll number and a tepid payrolls reading that was twice what Wall Street had forecast only add to the tightrope walk the Fed must walk.

In normal times, a strong job market and rising worker wages would have been considered high-profile issues. But this is a very good thing as the central bank tries to prevent persistent and problematic inflation.

“The Fed may take its foot off the gas at this point, fearing that inflation expectations will rise further,” Aneta Markowska, chief financial economist at Jefferies, wrote in a post-farm payrolls analysis in line with most of Wall Street Friday. “Wage growth remains in line with inflation at around 4%, showing how much more the Fed still has to do.”

Payrolls rose 263,000 in November, well ahead of the Dow Jones estimate of 200,000. Wages rose 0.6% month-on-month, more than double the estimate, while 12-month average hourly earnings accelerated to 5.1% from the 4.6% forecast.

All of these things add up to more of the same recipe for the Fed — sustained rate hikes, albeit slightly smaller than the three-quarters of a percentage point per meeting the central bank has maintained since June.

Little influence from policy actions

The figures show that the 3.75 percentage point rate hike has had little impact on labor market conditions so far.

“We really haven’t seen the impact of the Fed’s policy on the labor market yet, and that’s because the Fed is looking at job growth as a key indicator of its efforts,” said Elizabeth Crofoot, chief labor market economist at Lightcast, an analyst firm.

Much of the Street analysis after the report was viewed through the lens of Fed Chairman Jerome Powell’s comments on Wednesday. The head of the central bank announced a series of criteria he watches for clues about when inflation will fall.

Among them were supply chain issues, housing growth and wages, especially wages. He also went on to issue warnings on several issues, such as his focus on services inflation minus housing, which he thinks will reverse on its own next year.

“The labor market, particularly important for inflation in core services, is showing only early signs of rebalancing, and wage growth remains well above levels consistent with 2 percent inflation over time,” Powell said. “Despite some encouraging developments, we have a long way to go to restore price stability.”

In a speech at the Brookings Institution, he said he expected the Fed to reduce the size of interest rate hikes – a part that markets heard as the basis for the post-Powell rally. He added that the Fed would likely have to take interest rates higher than previously thought and leave them there for a long time, which was the part the market had overlooked.

“The November employment report … is what Chairman Powell was most concerned about earlier this week,” said Joseph LaVorgna, chief U.S. economist at SMBC Nikko Securities. “As labor supply continues to decline, wages are rising more than productivity. To restore labor supply and demand, monetary policy will need to be more restrictive and remain there for a long time.”

The road to ‘Goldilocks’

All is not lost, to be sure.

Powell said he still sees a path to a “soft landing” for the economy. This result seems likely to be no recession, or just a shallow one, nevertheless accompanied by a long trend of growth and at least some upward pressure on unemployment.

However, it will take a near-perfect storm to get there: Without massive layoffs, lower labor demand, easing supply chain bottlenecks, an end to hostilities in Ukraine, and a reversal of rising housing costs, especially rents. .

From a pure labor market perspective, that means a decline of perhaps 175,000 new jobs per month — to an average of 392,000 in 2022 — with annual wage growth in the 3.5% range.

There are some signs that the labor market is cooling. The Labor Department’s survey of households used to calculate the jobless rate showed a 138,000 drop in the number of people who said they were working. Some economists think the household survey and the business survey, which counts jobs rather than workers, could soon combine to show a weaker employment picture.

“The biggest disappointment was the number of wage increases,” Mark Zandi, chief economist at Moody’s Analytics, said in an interview. “We’re at 5% year-to-date. We’re not going anywhere fast, and that has to come down. That’s what we need to be most concerned about.”

Still, Zandi said he doubted Powell was too upset about Friday’s numbers.

“While the inflation outlook is highly uncertain at best, there is a path forward consistent with a Goldilocks scenario,” Zandi said. “263,000 vs 200,000 – that’s not a meaningful difference.”

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