The Fed's path to a "Goldilocks" economy just got a little complicated

The Fed’s path to a “Goldilocks” economy just got a little complicated

A ‘Help Wanted’ sign is displayed in a store window in Manhattan on December 02, 2022 in New York City.

Spencer Platt | Getty Images

As for the jobs reports, the November ones weren’t exactly what the Federal Reserve was looking for.

A higher-than-expected payrolls number and a hot payroll reading that was double what Wall Street had expected only add to the delicate tightrope the Fed must navigate.

In normal times, a strong labor market and rising wages for workers would be seen as high-class issues. But as the central bank seeks to stem persistent and troublesome inflation, this is too much of a good thing.

“The Fed can ill afford to ease off the gas at this point lest inflation expectations bounce higher,” Jefferies chief financial economist Aneta Markowska wrote in an analysis by post-nonfarm payrolls in line with most of Wall Street on Friday. “Wage growth remains consistent with inflation close to 4%, and that shows how much more work the Fed needs to do.”

Payrolls rose by 263,000 in November, well ahead of the Dow Jones estimate of 200,000. Wages rose 0.6% on the month, double the estimate, while the 12-month average hourly wage accelerated 5.1%, above the 4.6% forecast.

All of these things put together add up to a prescription of the same for the Fed — continued interest rate hikes, even if a little less than the three-quarters of a percentage point per meeting the central bank has had since June.

Little effect of policy changes

The figures indicate that 3.75 percentage points of rate increases so far have had little impact on labor market conditions.

“We don’t really see the impact of Fed policy on the labor market yet, and it’s concerning if the Fed sees job growth as a key indicator of its efforts,” Elizabeth Crofoot said. , senior economist at Lightcast, a labor market. analysis company.

Much of Street’s analysis after the report was seen through the lens of Fed Chairman Jerome Powell’s comments made on Wednesday. The head of the central bank outlined a set of criteria he was monitoring to know when inflation will fall.

Among them were supply chain issues, housing growth and the cost of labor, especially wages. He also cautioned on a few issues, such as his focus on services inflation minus housing, which he said will recede on its own next year.

“The labor market, which is particularly important for inflation in basic services excluding housing, shows only tentative signs of rebalancing, and wage growth remains well above levels that would be consistent with inflation of 2 % over time,” Powell said. “Despite some promising developments, we still have a long way to go to restore price stability.”

In a speech at the Brookings Institution, he said he expected the Fed to scale back the magnitude of its rate hikes — the part markets seemed to be hearing as the reason for a post-Powell rally. He added that the Fed would likely have to raise rates higher than previously thought and leave them there for an extended period, which the market seemed to ignore.

“The November jobs report … is precisely what Chairman Powell told us earlier this week he was most worried about,” said Joseph LaVorgna, chief US economist at SMBC Nikko Securities. “Wages are rising more than productivity as the supply of labor continues to shrink. To restore labor supply and demand, monetary policy must become tighter and stay there for an extended period.”

The path to ‘Goldilocks’

Of course, all is not lost.

Powell said he still sees a path to a “soft landing” for the economy. This outcome likely resembles no recession or a shallow recession, yet accompanied by a prolonged period of below-trend growth and at least some upward pressure on unemployment.

However, getting there will likely require a near-perfect storm of circumstances: a reduction in labor demand without mass layoffs, a continued easing of supply chain bottlenecks, a cessation of hostilities in Ukraine and a reversal of the upward trend in housing costs, particularly rents.

From a pure labor market perspective, that would mean a possible downgrade to perhaps 175,000 new jobs per month – the 2022 average is 392,000 – with annual wage gains of around 3.5%.

There are some signs that the labor market is cooling. The Labor Department’s Household Survey, which is used to calculate the unemployment rate, showed a drop of 138,000 people reporting work. Some economists believe that the household survey and the establishment survey, which counts jobs rather than workers, may soon converge and show a more muted picture of employment.

“The biggest disappointment has been strong wage growth,” 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 it has to come down. That’s the thing we have to worry about the most.”

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

“The outlook for inflation, while very uncertain at best, has a trajectory consistent with a Goldilocks scenario,” Zandi said. “263,000 versus 200,000 – that’s not a significant difference.”

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