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

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

A higher-than-expected payrolls number and a tepid wage reading that was twice what Wall Street had predicted only added to the dangerous tightrope the Fed must navigate.

In normal times, a strong job market and rising workers’ wages would be considered upper-class problems. But as long as the central bank seeks to curb persistent and rampant inflation, this is a very good thing.

“The Fed is unlikely to take its foot off the gas at this point for fear that inflation expectations will rise higher,” Jefferies chief financial economist Aneta Markowska wrote in a post-nonfarm payrolls analysis following most of the Wall Street Friday. “Wage growth has remained steady with inflation near 4%, and this shows how much more work the Fed still needs to do.”

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

All of those things together add up to a prescription for more of the same for the Fed — continued interest rate hikes, even if it’s a little less than the three-quarters of a percentage point at each meeting that the central bank runs. bank since June.

The numbers show that the 3.75 percentage point rate hike currently has little impact on labor market conditions.

“We have yet to see the impact of Fed policy on the labor market, and that’s about whether the Fed is looking at job growth as a key indicator of their efforts,” said Elizabeth Crofoot, senior economist at Lightcast. , a labor market. analytics company.

Much of the Street’s analysis after the report was viewed through the prism of comments made by Fed Chairman Jerome Powell on Wednesday. The central bank chief outlined a set of criteria he’s watching for signs of when inflation will drop.

These include supply chain issues, housing growth, and labor costs, especially wages. He also made caveats on some issues, such as his focus on inflation minus housing services, which he thinks will pay for itself next year.

“The labor market, which is particularly important for inflation in core services ex housing, shows only tentative signs of rebalancing, and wage growth remains above the level consistent with 2 percent inflation over time,” Powell said. “Despite some good developments, we have a long way to go to restore price stability.”

In a speech at the Brookings Institution, he said he hopes the Fed will cut the size of its rate hikes – the part that markets seem to be hearing as grounds for a post-Powell rally. He added that the Fed may have to take rates higher than previously thought and leave them there for a long time, which is the part the market seems to be ignoring.

“The November employment report … is exactly what Chair Powell told us earlier this week that she was most concerned about,” said Joseph LaVorgna, chief US economist at SMBC Nikko Securities. “Wages are rising more than productivity, while labor supply continues to decline. To restore labor demand and supply, monetary policy must become tighter and stay there for a long time. “

Of course, all is not lost.

Powell said he still sees a path to a “soft landing” for the economy. That outcome may seem like nothing short of a recession or just a shallow one, yet accompanied by a long period of low-trend growth and at least some upward pressure on unemployment.

Getting there, however, will likely require almost a perfect storm of circumstances: A reduction in labor demand without massive layoffs, continued easing of supply chain bottlenecks, a cessation of hostilities in Ukraine and a change in housing costs, especially rents. .

From a purely labor market perspective, that means an eventual downshift of perhaps 175,000 new jobs a month — the 2022 average is 392,000 — with an annual salary income in the 3.5% range.

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 decrease of 138,000 in those who said they were working. Some economists think the household survey and the establishment survey, which count jobs instead of workers, could soon merge and show a more bleak job picture.

“The biggest disappointment is the strong wage growth,” Mark Zandi, chief economist at Moody’s Analytics, said in an interview. “We’ve been at 5% since the beginning of the year. We’re not going anywhere fast, and that has to come down. That’s the thing we should be most concerned about.”

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

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