Federal Reserve policymakers are heavily focused on the strength of the job market as they debate how much further cooling the economy needs to ensure rapid inflation returns to normal paces. The new jobs data released on Friday probably did little to deter them from raising rates at their meeting later this month.
The June data is the latest payroll report officials will receive ahead of the central bank’s July 25-26 meeting. It underscored many of the labor market issues that have been present for months: although job growth is beginning to slow, wage growth remains unusually fast and the unemployment rate is very low at 3.6 percent.
Investors were already generally expecting the Fed to hike rates at its July meeting prior to the report, and June data confirmed that forecast. Many were paying particularly close attention to pay data: Average hourly wages rose 4.4 percent for the year to June versus 4.2 percent expected, and pay increases for May have been revised upwards. After months of deceleration, these earnings numbers have been roughly flat since March.
“All things considered, it’s strong enough for the Fed to feel confident that they still have some work to do,” said Michael Gapen, chief US economist at Bank of America, explaining that the report shows both signs of a early weakness as well as signs of continued strength. “New hires are cooling, but the job market is still hot.”
Fed officials are closely watching the wages data, fearing that if wage growth continues at an unusually fast rate, it may have a hard time returning elevated inflation fully to its 2% target. The logic? When companies pay their workers better, they may also increase their prices to cover their higher labor costs. At the same time, higher-income families are better able to cope with higher prices.
Fed officials were surprised at how stubborn the economy has been 16 months after trying to slow it down by raising interest rates, which is expected to make borrowing more expensive and cool consumer and business demand. Growth is slower, but the housing market has started to stabilize and the labor market has remained unusually strong, with ample opportunity and at least some bargaining power for many workers.
This resilience – coupled with the persistence of rapid inflation, particularly in the service sector – is why policymakers are expecting to raise interest rates further, which they have already raised above 5 percent for the first time in about 15 years. Officials have hiked rates by smaller increments this year than last year, and they missed a rate hike at their June meeting for the first time in 11 meetings. However, several policymakers have made it clear that they still expect rate hikes to continue despite a slowdown in the pace.
“It can make sense to skip a meeting and take it incrementally,” Lorie K. Logan, the president of the Federal Reserve Bank of Dallas, said in a speech this week, noting that it’s important for officials to keep raising rates .
She added that “a more or less expected development of inflation and the labor market would not really change the outlook.”
Fed officials predicted in June that they would raise interest rates twice more this year – assuming they would be in quarter-point increments – and that the job market would weaken, albeit slightly. They saw the unemployment rate rise to 4.1 percent by the end of the year.
Policymakers won’t release new economic forecasts until September, but Wall Street will be watching how policymakers react to economic developments to gauge whether another move is likely this year.
“Job growth has slowed but remains too strong to warrant an extended Fed pause,” said Seema Shah, chief global strategist at Principal Asset Management, explaining that the new data gave the Fed “little reason” to raise rates to hold back in July. The question is what happens after that.
At this point, investors think another rate hike after July is possible but not guaranteed, and the June jobs report has done little to change that.
The yield on the two-year government bond, which is sensitive to changes in investor expectations about future interest rates, fell from over 5 percent to around 4.9 percent. The move reflected, in part, investors’ relief that this week’s payrolls numbers had not followed a slew of other better-than-expected data points.
Some on Wall Street expect the economy to weaken more in the coming months, which could prompt the Fed to hold back on future rate hikes. Higher borrowing costs often take months or years to unfold their full economic impact, so another slowdown may already be on the horizon.
This month, one of Wall Street’s widely watched recession indicators, which compares short- and long-dated government bond yields, sent the strongest signal since the early 1980s that a downturn was imminent.
But Fed officials aren’t so sure. Austan Goolsbee, President of the Federal Reserve Bank of Chicago, said on CNBC on Friday that bringing inflation down without a recession would be a “triumph”.
“This is the golden road – and I feel like we’re on that golden road,” Mr Goolsbee said.