Last Friday saw the release of US nonfarm payrolls for the month of November. While the Fed has raised US interest rates by 3.75% this year, the numbers reveal that the jobs market does not seem to be feeling the tightening impact yet.
The breakdown is as follows. Payrolls grew by 263,000 in November, well ahead of the 200,000 Dow Jones estimate. Wages rose 0.6% on the month, double the estimate, while the 12-month average hourly earnings accelerated 5.1%, above the 4.6% forecast. The hotter than expected job market could complicate things for the Fed if it plans to pause rate hikes going forward as a red-hot labor market would usually be a precursor to inflationary pressures rising in the following months.
While the rate of inflation has slowed in November, there is a risk that a hotter than expected labor market could cause the rate of increase in inflation to rise again in the following months since a strong labor market with higher wages would boost spending power, which would likely cause the prices of goods and services to increase.
Remember that the Fed has two mandates to meet, one is inflation and the other is the labor market. Hence, while inflation is showing signs of cooling, a fiery jobs market could derail the softening inflation and drive prices higher again, especially as we approach the cold winter months where energy needs are increased and with increased spending during the year-end holiday season.
All of those things together add up to the same conclusion - that the Fed may think that rates need to continue rising in order to cool down the jobs market. This would put a dent in the sails for anyone betting on a Fed pause or even a rate cut next year, unless inflation cools off significantly from here.
Powell Mentioned Jobs Market Risk in Wednesday Speech
In last Wednesday’s speech that Fed Chair Powell made at the Brookings Institution in Washington DC, the central bank chief outlined a set of criteria he was watching for clues about when inflation will come down.
Among them were supply chain issues, housing growth, and labor cost, particularly wages. Last Friday’s jobs number incidentally proved that his concerns were spot on, with wage costs rising double the speed that analysts had expected.
Powell mentioned that he was more concerned about wage costs, which would pull up the core services price index, more than housing costs, which he thinks will come down on its own next year. To quote Powell as saying, “The labor market, which is especially important for inflation in core services ex housing, shows only tentative signs of rebalancing, and wage growth remains well above levels that would be consistent with 2 percent inflation over time. Despite some promising developments, we have a long way to go in restoring price stability.”
In the same speech, Powell said that he expected the Fed could cut the size of its rate hikes, but that they would have to take rates up higher than previously thought and leave them there for an extended period. However, strangely, the markets seem to be ignoring this warning but choose to only hear the part about reducing the rate hikes. Thus, should inflation climb up again in the coming months, the markets could be in for a rude shock.
Analysts Sounding Their Warning
Some analysts are already cautioning the overly dovish markets. One such analyst was Joseph LaVorgna, chief U.S. economist at SMBC Nikko Securities.
“The November employment report is precisely what Chair Powell told us earlier this week that he was most worried about,” said LaVorgna. “Wages are rising more than productivity, as labor supply continues to shrink. To restore labor demand and supply, monetary policy must become more restrictive and remain there for an extended period.”
Elizabeth Crofoot, senior economist at Lightcast, a labor market analytics firm, also voiced her concern. “We really aren’t seeing the impact of the Fed’s policy on the labor market yet, and that’s concerning if the Fed is viewing job growth as a key indicator for their efforts,” said Crofoot.
Friday’s jobs numbers indicated that the 3.75 percentage points worth of rate increases have so far had little impact on easing the tight labor market conditions. According to labor market experts, the Fed would need to see payroll downshifting to about 175,000 new jobs a month, with annual wage gains in the 3.5% range. Friday’s new jobs came in at 263,000, while annual wage gains were 5.1%.
Mark Zandi, chief economist at Moody’s Analytics, said in an interview with CNBC after the strong jobs number, “The biggest disappointment was the strong wage growth number,” “We’ve been at 5% since the beginning of the year. We’re not going anywhere fast, and that needs to come down. That’s the thing we need to worry about most.” However, despite sounding his concerns, Zandi said that he doubts Powell was too upset over Friday’s numbers since 263,000 vs 200,000 is not that meaningful a difference.
Time Will Tell If the Markets Are Right
While it is prudent to be cautious about the labor market condition causing inflation to rise again, it is worth pointing out that the labor market had been equally hot in October without fanning inflation higher in November. Thus, we could be overly cautious here and only time will tell if the markets are correct to take such a dovish stance. The next inflation number release will be on December 13, which happens to coincide with the first day of the Fed meeting slated for December 13-14. However, it is doubtful that even a rise in the December 13 number would change the Fed’s intention of a 50-bps rate hike. If inflationary pressures are to rise again, we could only see the Fed’s reaction in meetings next year. Thus, the markets appear to be safe as we move to the end of 2022, unless Powell says something on the contrary during the press conference after the December 14 meeting.
The above are the personal opinions of the author and should not be taken as the official view of the Margex platform. They are also not financial advice and are only meant to be informative in nature. Thus, they should not be construed as a solicitation to trade. Readers are strongly encouraged to do your own research, conduct due diligence, and assess your financial abilities before doing any investment or trading as these activities carry risks. Should you be in doubt, kindly speak with your personal financial advisor.