Hot labor market concerns Federal Reserve officials trying to tame inflation

A hot labor market that many economists have pointed to as a key factor in the U.S. avoiding slipping into a recession could prompt the Federal Reserve to go above its own expectations and increase interest rates even further this year over concerns inflation will not continue to decline.

The U.S. economy added an unexpected 517,000 jobs in January, according to the blistering report that came in well above economists’ predictions. Unemployment is also at its lowest level in more than 50 years at 3.4%.

A strong labor market throughout the pandemic has kept the economy propped up despite other issues like the inflation that is easing but still nagging consumers, the Fed’s interest rate increases and the potential for a recession as the central bank’s restrictive policy moves make their way through the economy.

Friday’s jobs report came a couple of days after the Fed raised its benchmark interest rate by 25 basis points, the smallest increase since the central bank began its crusade against record levels of inflation.

The Fed has kept a watchful eye on the labor market as it tries to bring inflation back to 2% year-over-year after it reached highs of 9.1% in June of 2022. The Fed’s benchmark interest rate is currently in a range of 4.5% to 4.75%, the highest since 2008.

Friday’s hot jobs report, along with revisions to previous data on the labor market that showed it was stronger than originally thought to close out 2022, could give Fed officials some concerns about easing off rate hikes.

“The continuous growth in the job market continues to put upward pressure on inflation and keep it above the desired level set by the Fed,” said Jadrian Wooten, collegiate associate professor of economics at Virginia Tech. “If the job market wasn’t expanding as rapidly, it’s likely that inflation would have cooled down at a faster pace.”

At an event at the Economic Club of Washington on Tuesday, Fed chairman Jerome Powell suggested that a continuation of hot jobs reports may lead governors to keep at it with rate increases.

We’re going to react to the data,” he said. “So, if we continue to get, for example, strong labor-market reports or higher inflation reports, it may well be the case that we have to do more and raise rates more than has been priced in.”

Fed officials have tried to slow down the rapid wage gains workers saw last year amid a crunch of available workers for businesses desperate to hire. Wage growth has moderated heading into the new year, but fears of a “wage-price spiral,” where businesses pass the added costs of keeping workers onto consumers still linger.

“Although recent data on wage growth has not indicated a wage-price spiral, the concern remains present,” Wooten said. “This is because inflation and unemployment rates have not been at such levels in recent decades, making it a new and uncertain situation for the economy. As a result, the Fed is likely to exercise caution and continue to monitor the situation closely to ensure that inflation remains in check and the economy remains stable.”

Inflation has shown signs of easing and has dropped to 6.5% on an annual basis, indicating there is still a long way to go for the Fed. Powell said he expects it to remain above the 2% goal through the year and into 2024.

It would be very premature to declare victory or to think that we’ve really got this,” Powell said Tuesday.

Fed governor Christopher Waller reiterated Powell’s points in an appearance Wednesday at Arkansas State University about their job not being done yet and said the labor market needs to come further into balance, citing all the recent strength shown in jobs data.

“Such employment gains mean labor income will also be robust and buoy consumer spending, which could maintain upward pressure on inflation in the months ahead. For employers, the very strong labor market makes it hard to find and retain workers,” Waller said. “One effect of this tightness is seen in wages and other compensation, which ultimately show up in the prices that consumers pay for goods and services.”

Powell and other Fed officials have been consistent in their messaging about bringing inflation in check and have not deviated from keeping restrictive monetary policy “for some time.”

Part of their goal is to manage expectations surrounding inflation and the potential for a recession. Americans have been battered with reports about high inflation and has seen higher prices at grocery stores and gas stations, adding to anxieties about the state of the economy.

Economists and several financial institutions have warned that the U.S. is headed for a recession this year, but Powell has maintained that he still sees a path for a “soft landing,” where inflation returns to what the central bank defines as acceptable levels without tipping the economy into a recession.

“After inflation, one of the major challenges facing the economy is the persistent perception that it is in a recession. Powell is responsible for fostering public confidence,” Wooten said. “This is crucial as widespread anxiety or negative sentiment can contribute to herd behavior and trigger a recession. Powell has been transparent about the need to bring down inflation and raise interest rates, which has helped to ease some of the worries among the public.