Fed officials have enough worrying inflation data to consider raising interest rates to a higher peak than investors were expecting and possibly following the half-point hike they announced earlier this month in February .
Monthly wages rose the most since January and US jobs rose more than forecast last month, a report on Friday showed. That will worry Fed Chair Jerome Powell, who warned this week that softening job conditions and slower earnings growth will be needed to cool inflation near a 40-year high.
Powell and his colleagues, now in their pre-meeting blackout, have strongly suggested they would downshift to a half-point at their Dec. 13-14 meeting after four consecutive 75 basis point raises. He also said they’ll likely need higher rates than they thought in September, when the median forecast put them at 4.6% next year versus a current target range of 3.75% to 4%.
“Powell has indicated that we are not yet in a wage growth spiral, but that risk is still there,” said Rhea Thomas, senior economist at Wilmington Trust Co.
Bets on a cut to a half-point hike this month were intact after the payrolls report was released, and investors once again looked to the probability for the Jan. 31-February 2 Fed. 1 session as approximately balanced. Futures market pricing shows that rates will peak at around 4.9% next year.
Officials will update their quarterly forecasts at the December meeting and could raise their median forecast for next year’s peak rate to 5% or more. St. Louis Fed President James Bullard has called for a peak of at least 5.25% and some analysts, including Diane Swonk, chief economist at KPMG LLP, see rates as high as 5.5% with the Fed poised , triggering a recession if needed to restore price stability.
Inflation “metastasizes” if left untreated
“Inflation is like cancer: if left untreated, it metastasizes and becomes much more chronic,” Swonk said. “The cure” of higher interest rates means “2023 is going to be a tough year”.
Fed officials will receive an additional CPI report ahead of the December meeting and will have another month of data to ponder before meeting again early next year.
Powell said Wednesday that rising wages are likely “a very important part of the inflation story.” While difficulties in the supply chain for goods appear to be easing, improving price prospects in the sector, he said wages are the biggest cost for the service sector, so working conditions are key to understanding price prospects for everything from hotels to to haircuts.
The jobs report showed that average hourly wages rose 0.6% in November, a broad-based increase that was the largest since January and up 5.1% from a year earlier. Manufacturing and non-supervisory wages rose 0.7% mom, the fastest in almost a year. The pace of pay rises is not in line with the Fed’s 2% inflation target.
“The labor market is still under pressure, and if anything, it’s as bad as before,” said Vincent Reinhart, chief economist at Dreyfus and Mellon. “They want a little more real restraint as they believe — at least Powell believes — that inflationary pressures are deeply embedded in consumers’ price baskets.”
While central bankers have set a target of below-trend growth to ease price pressures, the creation of 263,000 jobs last month – which has kept the unemployment rate at 3.7% – is the latest evidence that the US -Economy remains resilient. According to the Atlanta Fed’s tracking estimate, fourth-quarter growth could be 2.8%, well above estimates of what’s sustainable over the long term.
While Fed executives have hinted that there is scope for a 50 basis point cut this month, they have attempted to keep investor focus on interest rate spikes due to the size of the moves made at each meeting.
They have also stressed the cumulative impact of previous increases and the notion that the policy works with a lag. That encourages speculation that next year they may retreat to 25 basis points to reduce the risk of going too far.
Still, the latest jobs report could prompt officials to consider another 50 basis points early next year.
“The Fed — and Powell in particular — is very focused on labor market-driven sources of inflation, and this report will keep him on high alert,” said Thomas Costerg, senior US economist at Pictet Wealth Management. “I think they can go ahead with another 50 at the next Fed meeting.”
“These labor shortages have helped fuel inflation”
The labor force is growing much slower than expected, with 3.5 million fewer workers than expected after Covid-19 prompted early retirement and changing work patterns from 2020. This will not change in the foreseeable future.
“These labor shortages have helped feed inflation,” Richmond Fed President Thomas Barkin said on Friday, and as US baby boomers retire, this is likely to continue for the long term. Although the Fed was quick to hike rates, “we’ve seen that labor demand continues to outpace supply,” he said.
At the forthcoming meeting, Fed officials may also want to highlight their steadfastness on higher rates to lean on Wall Street, which has responded to the proposed downgrade with a potentially unwelcome easing of financial conditions. The Fed has deliberately tried to tighten conditions to reduce demand and ease price pressures.
“Broader funding terms are becoming easier. I don’t realize the Fed is making much progress,” said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC. “The Fed still has a lot of work to do to cool the economy enough, and particularly the job market, enough to get where it wants to be in terms of inflation. We’re definitely not that far yet.”
– With the support of Rich Miller.
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