WASHINGTON (AP) – Does the Federal Reserve have it wrong?
For months, the Fed has been carefully watching the US economy’s strong job gains over concerns that employers, desperate to hire, will keep raising wages and, in turn, keep inflation high. But January’s staggering job growth coincided with a real slowdown in wage growth. And it eased several inflationary measures in recent months.
Last year’s continued strong hiring gains have defied the Fed’s sharpest hike in its benchmark interest rate in four decades — an aggressive effort by the central bank to cool hiring, economic growth and spiking prices has kept American households safe for nearly two years. Has troubled
Yet economists were stunned when the government reported on Friday that employers added an explosive 517,000 jobs last month and the unemployment rate fell to a 53-year low of 3.4%.
“Today’s jobs report is almost too good to be true,” said Julia Pollack, chief economist at ZipRecruiter. “Like $20 bills on the sidewalk and free lunches, falling inflation coupled with falling unemployment is the stuff of economics’ fantasy.”
In the economic model used by the Fed and most mainstream economists, a job market with strong hiring and a low unemployment rate typically fosters high inflation. Under this scenario, companies feel compelled to increase wages in order to attract and retain workers. They often pass those higher labor costs on to their customers by raising prices. Their higher paid employees have more money to spend. Both trends can feed into inflationary pressures.
Yet year-on-year inflation has slowed from a peak of 9.1% in June to 6.5% in December, despite hiring being solid over the past six months. Much of that decline reflects cheaper gas. But excluding volatile food and energy costs, the Fed’s preferred inflation gauge has risen at about a 3% annual rate over the past three months — so far not above its 2% target.
Those trends have raised questions about a key aspect of the Fed’s high rate policy. Chair Jerome Powell has said that overcoming inflation will require “some pain”. And Fed policymakers have projected that the unemployment rate will rise to 4.6% by the end of this year. In the past, such large increases in the unemployment rate have only occurred during recessions.
Yet Friday’s report points to the possibility that the long-standing correlation between a strong job market and high inflation has broken down. And this breakdown holds a tantalizing possibility: that inflation may continue to decline while employers continue to add jobs.
“Their model is that this inflation is driven exclusively by wage inflation,” said Preston Mui, senior economist at Employ America, an advocacy group. “To mitigate it, they think we have to inflict some pain on the labor market in terms of high unemployment. And what the last three months have shown us is that this model is absolutely wrong.”
That said, it’s possible that Friday’s report could still move the Fed in the opposite direction: Continued strong job growth could give Powell and other officials confidence that, despite signs of slowing wage growth, a powerful job The market will inevitably rule inflation. If so, then their benchmark rate would have to remain high for the pace of recruitment to cool.
With that outlook in mind, Wall Street traders are now pricing in an additional Fed rate hike this year: Investors have a 52% chance the Fed will raise its benchmark rate by a quarter-point in both March and May. Will give 5% to 5.25%. This is the same level that Fed officials themselves predicted in December.
Many economists say the pandemic has so disrupted the job market that it is operating differently than in the past.
Labor Secretary Marty Walsh said on Friday, “There are a lot of norms….that are no longer normal.” “We’re seeing a lot of companies not doing the layoffs in January that they usually do, because they went through a pandemic where they lost people and they didn’t come back.”
In a news conference this week, Powell argued that much of the drop in inflation since the fall reflected falling prices for goods — items like used cars, furniture and shoes — as well as sharply lower gas prices. He suggested that those price declines reflect the clearing of previously closed supply chains, and will likely prove temporary.
And Powell reiterated one of his central concerns: inflation in the labor-intensive services sector is still rising at a steady pace of 4% and shows no signs of slowing. Much of that growth is the result of strong wage growth at restaurants, hotels and transportation and warehousing companies, with fewer workers available to do such work.
“My own view,” the Fed chairman said, “would be that without a better balance in the labor market you will not have a sustainable return to 2% inflation in that sector.”
Yet even with vigorous job gains, many measures of wage growth show a steady easing: Average hourly wages rose 4.4% in January from a year earlier, down from a peak of 5.6% in March.
“The earnings data deserves more attention,” Rob Cleary, investment strategist at Evelyn Partners, said in a research note. “Higher headline (job) reading does not translate into further inflationary pressures – an important finding for the Fed.”
