The Fed’s path to a “Goldilocks” financial system simply acquired extra difficult

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

Spencer Platt | Getty Images

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

A higher-than-expected number of payrolls and a hot wage figure that was double Wall Street’s forecast only adds to the delicate balancing act the Fed must walk.

In normal times, a strong job market and rising worker paychecks would be seen as high-class issues. But as the central bank tries to rein in persistent and irksome inflation, this is overkill.

“The Fed cannot afford to take its foot off the gas at this point for fear that inflation expectations will rise again,” Jefferies chief financial economist Aneta Markowska wrote in a post-nonfarm payroll analysis consistent with most of Wall Street Friday. “Wage growth remains consistent with inflation hovering near 4%, showing how much work the Fed has to do.”

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

All of these things add up to a recipe for more of the same for the Fed — continued rate hikes, even if they’re a little less than the three-quarters of a percentage point per meeting the central bank has been conducting since June.

Little effect of political measures

The numbers suggest wage increases of 3.75 percentage points have so far had little impact on labor market conditions.

“We really aren’t seeing the impact of Fed policy on the jobs market yet, and that’s worrying when the Fed looks at job growth as a key indicator of its efforts,” said Elizabeth Crofoot, senior economist at Lightcast, a jobs analysis firm.

Much of the post-report Street analysis was viewed through the prism of comments made by Fed Chair Jerome Powell on Wednesday. The central bank governor outlined a number of criteria he is monitoring for clues as to when inflation will ease.

Among them were supply chain issues, housing growth and labor costs, particularly wages. He also set about setting caveats on some issues, such as his focus on services inflation minus housing construction, which he thinks will decline on its own over the next year.

“The labor market, which is particularly important for inflation in core non-housing services, is showing only tentative signs of rebalancing, and wage growth remains well above levels that would correspond to 2 percent inflation over time,” Powell said. “Despite some promising developments, we still have a long way to go to restore price stability.”

Speaking at the Brookings Institution, he said he expects the Fed could trim the scope of its rate hikes — the part that 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 was the part the market seemed to ignore.

“The November jobs report … is exactly what we were most concerned about from Chairman Powell earlier this week,” said Joseph LaVorgna, US chief economist at SMBC Nikko Securities. “Wages are growing faster than productivity as labor supply continues to shrink. To restore labor demand and supply, monetary policy needs to become tighter and stay tight for a longer period of time.”

The way 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 looks like there will be either no recession or only a mild one, but accompanied by a prolonged period of below-trend growth and at least some upward pressure on unemployment.

Getting there, however, will likely require a near-perfect storm of circumstances: a reduction in labor demand without mass layoffs, a further reduction in supply chain bottlenecks, an end to hostilities in Ukraine, and a reversal of the upward trend in housing costs, particularly rents .

From a pure jobs perspective, that would ultimately mean a drop to perhaps 175,000 new jobs per month – the average for 2022 is 392,000 – with annual wage increases in the region of 3.5%.

There are signs that the labor market is cooling off. The Labor Department’s household survey, which is used to calculate the unemployment rate, showed a drop of 138,000 in those who said they worked. Some economists believe the household survey and the enterprise survey, which counts jobs rather than employees, may soon converge and show a more subdued employment picture.

“The biggest disappointment was strong wage growth,” said Mark Zandi, chief economist at Moody’s Analytics, in an interview. “We’ve been at 5% since the beginning of the year. We’re not going anywhere fast, and that needs to go down. That is what we have to worry about the most.”

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

“The inflation outlook, while very uncertain at best, shows a path forward consistent with a Goldilocks scenario,” Zandi said. “263,000 vs. 200,000 – that’s not a significant difference.”

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