U.S. jobs data keep the Fed on track for a May rate hike

Federal Reserve officials are likely to raise interest rates by another quarter point next month, as risks of a financial crisis ease and inflation concerns remain high amid a historically low unemployment rate.

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There has been a slowdown in the growth of jobs in the U.S., something that Fed policymakers have anticipated while raising borrowing costs. Despite all this, the economy still added 236,000 jobs in March and has added an average of 345,000 jobs each month over the course of the first quarter, well above the level that the central bank considers consistent with its aim of keeping inflation at 2%.

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Despite the increase in labor force participation and the addition of about half a million people to the labor force last month, the unemployment rate fell to 3.5% last month from 3.6% in February. The average hourly wage increased by 0.3% over the last month, a slight improvement compared to the previous month.

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Before the Fed's policy meeting on May 2-3, the latest jobs report will provide the last broad glimpse of the labor market that officials will receive. It represents another step towards shifting the focus away from a potential crisis caused by the collapse of two regional banks to their efforts to combat high inflation that has been ongoing for years.

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The market is betting that rates will continue to rise, with bets on a quarter-of-a-point rise next month now seen as a nearly two-thirds chance, at least, among investors in contracts linked to the Fed's benchmark overnight interest rate.

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"Even though employment readings have weakened in the wake of the non-farm employment report, employment growth hasn't yet collapsed, although there are signs that it will continue to be moderate," Kathy Bostjancic, chief economist at Nationwide, wrote shortly after the report was released.

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Bostjancic said that "the Fed would generally be pleased with the data, although she added that yet another rate hike will not be ruled out in May - which we believe could be the last hike in this tightening cycle. Followed by a long pause."

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This may be a further indication of easing inflationary pressures, as the pace of wage growth on a year-over-year basis fell to 4.2% in March, down from 4.6% in February. This continues a recent downward trend in wage growth.

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In a Trade Algo poll, economists expected to see an increase of 239,000 jobs in March, with hourly earnings increasing at a rate of 4.3% annually and the unemployment rate remaining at 3.6%, a level that is less than 20% of what it was during the age of World War II.

According to the Federal Reserve's goal of a 2% annual increase in the Personal Consumption Expenditures price index, payroll growth is expected to have averaged 180,000 per month before the COVID-19 pandemic, and wage growth is expected to remain within the range of 2%-3% as seen by policymakers prior to the outbreak.

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In February, the PCE price index was rising 5% annually, or 4.6% if volatile food and energy prices are excluded. This is too high for the Fed's liking and improvement has only been coming slowly in the last few months.

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Gregory Daco, chief economist at EY Parthenon in advance of the report, had said he expected it to show that "labor market tightness will continue to be a feature of this cycle, and the Fed will continue to raise interest rates in the coming months."

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Still Hot?

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It is now a matter of waiting to see how long that current economic cycle might last, and whether the seeds of a serious slowdown are already taking root.

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Fed officials at their March meeting predicted that the median unemployment rate for the end of 2023 would be 4.5%, indicating that there would be a relatively steep rise in unemployment, which in the past would be indicative of a recession in the making.

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It would be impossible for Fed officials to say that their goal is to cause a recession. There is, however, no escaping the fact that they've also made it clear that, at present, there are too many jobs competing for too few workers, which is a recipe for wage and price increases that could start to amplify one another if the situation continues for long enough.

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Despite the tight labor market, Susan Collins, President of the Boston Fed, in an interview with Trade Algo last week, stated that unemployment is still at an extremely low level, which is quite unusual for the time of year. "In order to bring inflation back to the Federal Reserve's target level, we most likely won't see the slowdown we probably need until the labor markets cool, at least to some degree."

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It is possible, however, that change is on the way.

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Among the developments noted by Daco in the report is the decline in the average number of weekly hours worked during the month of February, which, according to him, bears monitoring for signs of "an increasingly worrying slowdown in the labor market." The average workweek fell to 34.4 hours in March from 34.5 hours in February.

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UKG, a payroll provider that monitors the payrolls of 35,000 companies, reported that shift work declined 1.6% in March, a non-seasonally adjusted figure that Dave Gilbertson, a vice president at the company, said indicated overall job growth that was positive but that not as pronounced as some of the recent spikes have been. Despite expectations of smaller job growth in January and February, the number of jobs was higher than expected, and for a brief moment, Fed officials thought they might have to increase interest rates to keep inflation at bay, a sentiment that faded after Silicon Valley Bank and Signature Bank failed recently.

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The Conference Board, on the other hand, said it has constructed a new index that combines economic, monetary policy, and demographic data that suggests 11 of the 18 major industries are at low-to-moderate risk of outright layoffs this year.

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There has been a lot of gloomy talk in the economic press lately regarding the likelihood of a recession starting sometime between now and the end of June, according to economists from the Conference Board, but it is anticipated to take some time before job losses become widespread, according to Frank Steemers, a senior economist at the think tank.

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Eye on Services

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It may be starting to happen to some extent.

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In new figures released by the Labor Department on Thursday, over 100,000 additional people have recently been receiving unemployment benefits than had previously been estimated by the Labor Department's measure of jobless benefits rolls. Moreover, the outplacement firm Challenger, Gray & Christmas said that the roughly 270,000 layoffs announced so far this year through March were the highest quarter-over-quarter total outside of the pandemic period since 2009.

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This is only a small part of the puzzle for the Fed, however. The extent to which "slack" in the labor market relates to lower inflation may be determined by the pace at which job growth slows, as well as the length of the slowdown.

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Researchers at the Kansas City Fed have found that the process may prove to be more difficult than expected because the service sector industries that are driving wage growth and inflation are those that are the least sensitive to changes in monetary policy and these are the ones that have the most impact on the economy.

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It is known that when the Federal Reserve raises interest rates, industries like manufacturing and building deteriorate as credit gets more expensive, which results in a slowdown in demand and employment. However, the Kansas City Fed economists Karlye Dilts Stedman and Emily Pollard pointed out that the service industries, which make up the bulk of U.S. economic output, are more labor-intensive and less sensitive to interest rate increases than the manufacturing sector.

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They state that the services sector, particularly, has contributed significantly to recent inflation, reflecting ongoing imbalances in labor markets, in which the supply of labor remains impaired and the demand for it remains strong. "Considering that service production tends to be less capital intensive and that services consumption is less likely to be financed, it also tends to respond less quickly to rising interest rates compared to other sectors, including manufacturing and agriculture. Therefore, it may take longer for monetary policy to influence one of the principal sources of current inflation."