U.S. jobs report breathes life into Fed’s ‘soft landing’

Reuters

13:53 JST, January 7, 2023

NEW ORLEANS/SAN FRANCISCO (Reuters) — A jump in the workforce and easing wage growth suggests the U.S. job market is starting to move the way the Federal Reserve has hoped it will, to bring the supply and demand for workers into better balance and help in its battle against inflation.

After a year in which many basic metrics of the jobs market stalled at levels the U.S. central bank feels are inconsistent with stable prices, employment data for December published on Friday brought a hint of relief.

Nearly 165 million people were either in jobs or looking for them last month, a record high that showed a long-hoped-for improvement in labor supply. U.S. firms added 223,000 payroll jobs to cap a year in which 4.5 million people were hired, a total exceeded in the post-World War Two era only by 2021’s 6.7 million.

At the same time, hourly wages — the price of labor — grew at the slowest annual pace in 16 months and has dropped by a full percentage point since the end of the first quarter of 2022. Weekly average earnings gained 3.1%, the slowest pace since May 2021.

The jobs report is “the embodiment of the soft landing narrative — this idea that can you have a strong labor market with slowing wage growth,” said Simona Mocuta, chief economist at State Street Global Advisors.

“You can kind of, in this case, have your cake and eat it too,” she added, with earnings growth coming off the boil but no collapse in labor demand or widespread layoffs.

Ideally, she said, that should allow the Fed to slow and soon pause its interest rate hikes.

Traders took the report as evidence the Fed’s work is near to being done. U.S. stocks rose and interest-rate futures traders added to bets the Fed will slow its rate hike pace further at its Jan. 31-Feb. 1 meeting and ultimately stop short of the 5.00%-5.25% policy rate range that nearly all U.S. central bankers have signaled they believe will be needed to bring inflation to heel.

Fed policymakers, however, had a decidedly more sober take on Friday’s data, signaling they are locked into further rate hikes and will want to see a lot more data confirming easing of price pressures before they stop the tightening.

Atlanta Fed President Raphael Bostic on Friday said he expects the policy rate this year to get to the range just above 5.00% that he and his colleagues signaled last month and stay there until “well” into 2024.

That’s a stark contrast to traders’ expectations for the policy rate, now in the 4.25%-4.50% range, to top out at 4.75%-5.00% and then for the Fed to begin cutting borrowing costs in the second half of this year.

“Today I would be comfortable with either a 50 or a 25 [basis-point increase],” Bostic told broadcaster CNBC, referring to the Fed’s upcoming rate-setting decision. “If I start to hear signs that the labor market is starting to ease a bit in terms of its tightness, then I might lean more into the 25-basis-point position,” he said, adding that at this point he doesn’t see wages as driving inflation.

Minutes of last month’s policy meeting, which were published this week, reflected the anxiety the Fed has over how the labor market was affecting its inflation fight, with officials worrying that core inflation components “would likely remain persistently elevated if the labor market remained very tight.”

The U.S. unemployment rate fell back to a pre-pandemic low of 3.5% in December.

The employment data, while only reflecting a single month, nonetheless presented a welcome easing in some of those dynamics that have weighed so heavily on officials’ minds in their bid to keep reducing inflation, which was running at the highest rates in 40 years in the middle of last year.

By the Fed’s preferred measure, the personal consumption expenditures price index, inflation rose at an annual rate of 5.5% in November, down from earlier in 2022 but still more than twice the central bank’s 2% target.

The Fed pulled out all the stops last year in its bid to quash inflation, taking its policy rate from near zero in March to the current level in the swiftest series of rate hikes in more than a generation.

More inflation data due next week will play into the Fed’s calculus about where to go in the months ahead, with the Labor Department’s Consumer Price Index expected to show price pressures had softened further in December. The annual CPI rate is expected to have dropped to a 14-month low of 6.5% in December from 7.1% in the prior month, and the month-to-month rate is forecast to have been unchanged, an abrupt turnaround for a measure that had been running at its highest rate since the early 1980s just six months earlier.

“We have seen the inflation dynamics in the U.S. slow significantly,” Robin Brooks, chief economist at the Institute of International Finance, said on Friday at the annual meeting of the American Economic Association (AEA) in New Orleans. “That is a very real development. And it has more or less persisted.”

“That’s really good news.”

That may be true, but Fed officials — who got caught flatfooted in their early response to inflation’s surge — are far from chiming victory bells.

“Recent data suggest that labor-compensation growth has indeed started to decelerate somewhat over the past year,” Fed Governor Lisa Cook told the AEA meeting.

Still, she said, “inflation remains far too high, despite some encouraging signs lately, and is therefore of great concern.”