Steaming US jobs market gives Fed green light on rate hikes

It is not as if United States central bankers needed more reasons to step up the pace of interest rate raises.

But that is what they got on Friday, when the Bureau of Labor Statistics latest jobs report showed employers added 431,000 to payrolls last month and the unemployment rate fell to a two-year low of 3.6 percent.

All are signs of a strong labour market with little need for the kind of super-easy monetary policy that the Fed is currently delivering and has begun to unwind.

“A very tight labour market got even tighter,” wrote Oxford Economics’ Kathy Bostjancic and Lydia Boussour.

Futures contracts tied to the Fed’s policy rate fell after the jobs report, as expectations intensified that the Fed will go bigger at the Fed’s next three meetings, raising by a half-a-percentage point each time to deal a more decisive blow to price pressures.

Rate futures contracts reflect odds-on bets for the policy rate to end the year in the range of 2.5 percent to 2.75 percent, with about a one-in-three chance of going even higher. Either way that is high enough to put the brakes on growth.

It was just two weeks ago that the Fed raised interest rates by a quarter-of-a-percentage point in its first policy tightening in three years, and signaled ongoing rate raises ahead to rein in inflation at a 40-year high and climbing.

With average hourly pay that is 5.6 percent higher than a year earlier, March’s labour market report reflected strong demand for workers despite rising borrowing costs that may, to central bankers, also contain a warning signal for a building “wage price spiral” that could make inflation even worse.

At their mid-March meeting, policymakers had projected an end-of-year policy rate of about 1.9 percent. Since then a number, including Fed Chair Jerome Powell, have signaled their readiness to move faster.

Chicago Fed President Charles Evans, who personally prefers the more measured path, told reporters Friday that he does not see a big risk in using “some” half-point rate raises to bring borrowing costs to neutral sooner, as long as the goal was not to raise rates much faster and push them much higher.

The worry there would be that the Fed ends up tightening too much, tipping the economy into recession. Historically it has been rare that the Fed has avoided such an outcome once the unemployment rate falls as low as it is now.

With inflation looking set to accelerate even more after Russia’s invasion of Ukraine sent oil prices higher and a COVID-19 outbreak in China threatens to further damage already strained supply chains, tamping down inflation is “essential” to sustaining a strong labour market, Fed’s Powell has said.

The Fed targets 2 percent inflation by a measure known as the personal consumption expenditures price index. In February that measure jumped to 6.4 percent.

Policymakers do not want to risk that expectations for ever-higher prices get baked into American household and business psychology. Rate raises are designed to curb demand and blunt that risk.

Besides, policymakers have argued, the labour market has met the standard of full employment, and is strong enough to withstand the kind of fairly rapid withdrawal of support they are contemplating.

Friday’s report offered more grist for that argument. The unemployment rate was “little different” than the pre-pandemic rate of 3.5 percent, the report’s authors said.

And it helps ratify the Fed’s hope that workers sidelined by the pandemic would find their way back to the labour force as COVID-19 cases fall.

Participation in the labour force by workers in their “prime” years of 25 to 54 rose to 82.5 percent, the highest level in two years. Most industries are now above or close to their pre-pandemic level of employment

US employment overall is still 1.6 million below the pre-pandemic level, the report showed.

But Fed policymakers increasingly see that deficit as likely to get filled only slowly and not prone to be hurried along by keeping rates low.

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