By Howard Schneider
WASHINGTON (Reuters) – The slide in inflation that gathered pace at the end of 2023 has begun shifting attention at the U.S. Federal Reserve to the health of the job market, with officials increasingly attuned to the risks of keeping monetary policy too tight for too long and watching for evidence of stress in business hiring plans.
The monitoring ranges from focused talks with local executives about whether layoffs are anticipated for the year, to a closer look at what industry employment patterns say about the health of the job market overall, and an ongoing debate over whether still-elevated wage growth risks rekindling inflation.
The shift in focus comes as the Fed must decide in coming months the point at which the risks of slowing the economy more than needed to curb inflation outweigh the likelihood that inflation will resurge. It’s a judgment in effect of whether officials have done enough to control the pace of price increases and now need to protect the employment side of their two congressionally mandated goals.
It’s a consequential decision for November’s U.S. presidential election, given the stakes for both parties if voting takes place with inflation controlled, interest rates falling and unemployment still low – the “soft landing” trifecta the Fed appears to be approaching – or, alternately, with still-tight monetary policy, expensive credit, and potentially rising joblessness.
While policymakers generally still focus on the fact that inflation is above the Fed’s 2% target, the commentary has become more two-sided.
“I’ve got a natural bias to be tighter” to ensure inflation is controlled, Atlanta Fed President Raphael Bostic said this week.
But the concentration of recent hiring in a handful of industries like health and education “means that the slowdown is actually happening” through much of the economy, Bostic said. “The question is does that continue…on a smooth path? Or do we get to a place where it slows down so much that we are near a cliff?…We need to be getting touch points on a regular basis so we can see the change as it’s happening and not find out like two months later.”
‘CRACKS’ EMERGING
The central bank next meets on Jan. 30-31, and policymakers are expected to leave their benchmark interest rate steady at the current 5.25% to 5.5% range. Still, their policy statement and Fed Chair Jerome Powell’s comments at a post-meeting press conference should shed light on how confident officials are that inflation is contained and how close they are to cutting rates.
A majority of officials feel rates will need to fall this year to between 4.50% and 4.75%, a decision to be shaped by inflation data but also by whether and how quickly job growth slows.
Minutes of the Fed’s December decision showed emerging concern about the risks ahead, with a few officials pointing to a difficult “tradeoff” possibly approaching between further inflation control and marked job losses, and “several” Fed officials worried the economy “could transition quickly…to a more abrupt downshift.”
There’s no evidence of that yet, with the latest data showing solid monthly job gains and the unemployment rate below 4% for nearly two years, the best such stretch since the late 1960s.
But it may be just below the surface.
Sarah House, senior economist with Wells Fargo Corporate and Investment Banking, last week pointed to “cracks” in the job market including a steady decline in temporary workers, something that has signaled previous business cycle turns, and a drop in average hours worked. She expects employment gains this year to fall below the roughly 100,000-per-month pace needed to keep the unemployment rate steady.
Such data “doesn’t bode well for momentum as we head into 2024,” she said.
‘HARDER FROM HERE’
For now, though, the underlying sense among policymakers including Powell is the labor market remains in a healthy transition from the outsized job and wage gains of the pandemic to something more sustainable while the inflation fight remains incomplete.
At his December press conference Powell noted the comfortable space the Fed has operated in of late, with “the labor market coming into better balance without a significant increase in unemployment, inflation coming down without a significant increase in unemployment, and growth moderating without a significant increase in unemployment.”
Yet it was largely due, he said, to improvements in the supply side of the economy, including an unexpected surge of workers into the job market and a jump in productivity. None of that is guaranteed to continue.
“At some point you will run out of supply-side help,” Powell said. “We kind of assume that it will get harder from here.”
“Harder,” in the current context, means completing the inflation fight would still require the sort of old-school blow to demand that could cause rising joblessness.
Past U.S. experience navigating that process has not been pleasant. Increases in the jobless rate of half a percentage point over the course of a year, for example, are historically associated with recession, and are typically followed by further increases in joblessness – a “hard landing” rather than the gentle descent from high inflation the Fed hopes to oversee.
Monetary policy can be slow to impact the economy, with a hard-to-estimate time lag between Fed decisions to change interest rates and the borrowing, spending, and employment decisions of businesses and households that influence inflation.
Those lags concerned the Fed when it came to controlling inflation that erupted in 2022 to a 40-year high. They remain in play as inflation slows and central bankers anticipate how much further they need to restrain economic activity without going too far.
“We should normalize rates as the economy gets back to normal,” Richmond Fed President Thomas Barkin told reporters last week, but added he was still building “confidence and conviction” that the easing of price pressures would spread broadly through the economy.
“I don’t have any objection conceptually to toggling rates back towards normal levels as you build increasing conviction and confidence that inflation is on a convincing path back to your target,” he said.
(Reporting by Howard Schneider; Editing by Dan Burns and Andrea Ricci)
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