Fed could be pushed by overheated wages to higher peak rates
FEDERAL Reserve officials have enough worrisome inflation data to consider raising interest rates to a higher peak than investors expect and potentially follow the half-point hike they’ve signalled this month with the same again in February.
Monthly wages rose at the strongest pace since January and US employment surged more than forecast last month, a report showed last Friday (Dec 2). That will concern Fed Chairman Jerome Powell, who last week cautioned that slacker job-market conditions and less-lofty earnings growth were needed to cool an inflation rate near a 40-year high.
Powell and his colleagues, now in their pre-meeting blackout, have strongly suggested they would downshift to a half-point move at their Dec 13-14 gathering, after four straight 75 basis-point increases. He’s also said they likely will need higher rates than they thought in September, when the median forecast saw them at 4.6 per cent next year from a current target range of 3.75-4 per cent.
“Powell has suggested that we’re not in a wage-growth spiral yet, but that risk is still there,” said Rhea Thomas, senior economist at Wilmington Trust. “This keeps in play this idea that they may have to raise the peak rate and potentially keep it in place for longer.”
Bets on a downshift to a half-point hike this month were intact after the employment report and investors saw the likelihood of the same again at the Fed’s Jan 31-Feb 1 meeting as roughly balanced. Pricing in futures markets shows rates peaking around 4.9 per cent next year.
Officials will update their quarterly forecasts at the December meeting and could lift their median projection for the rate peak next year to 5 per cent or above. St Louis Fed President James Bullard has called for a minimum 5.25 per cent peak and some analysts, including Diane Swonk, chief economist at KPMG, see rates as high as 5.5 per cent, with the Fed willing to cause a recession if necessary to restore price stability.
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“Inflation is like a cancer: if not treated, it metastasizes and becomes much more chronic,” Swonk said. “The cure” of higher rates means “it’s going to be a rough 2023”.
Fed officials will get an additional consumer-price report before the December meeting and have another month of data to mull over before they gather again early next year.
Powell on Wednesday said that rising wages are likely to be “a very important part of the story” on inflation. While supply-chain difficulties seem to be easing for goods, helping the price outlook in that sector, he said that wages are the largest cost for the services sector, so labour conditions are key to understanding the outlook on prices on everything from hotels to haircuts.
The jobs report showed average hourly earnings jumped 0.6 per cent in November in a broad-based gain that was the biggest since January, and were up 5.1 per cent from a year earlier. Wages for production and non-supervisory workers climbed 0.7 per cent from the prior month, the most in almost a year. The pace of pay raises is inconsistent with the Fed’s 2 per cent inflation target.
“Pressures remain in the labour market and if anything are as bad as they’ve been,” said Vincent Reinhart, chief economist at Dreyfus and Mellon. “They want a little more real restraint, given that they believe – at least Powell believes – inflation pressures are embedded deeply into the consumer price basket.”
While central bankers have set a goal of below-trend growth to cool price pressures, the addition of 263,000 jobs last month – leaving the unemployment rate at 3.7 per cent – is the latest evidence that the US economy remains resilient. Growth in the fourth quarter may be 2.8 per cent, well above estimates of what is sustainable in the long term, according to the Atlanta Fed’s tracking estimate.
While Fed leaders have suggested there’s scope to moderate to 50 basis points this month, they have sought to shift the focus of investors to where rates peak from the size of moves made at each meeting.
They have also emphasised the cumulative impact of prior increases and the notion that policy works with a lag. That’s encouraged speculation they could step down to 25 basis-point moves next year to reduce the risk they go too far.
Even so, the latest jobs report could prod officials to consider another 50 basis points early next year.
“The Fed – and Powell in particular – is very much focused on labour-market driven sources of inflation and this report will keep him on high alert,” said Thomas Costerg, senior US economist at Pictet Wealth Management. “I think they can carry on with another 50 at the following Fed meeting.”
The labour force is growing much more slowly than expected, with 3.5 million fewer workers than expected after Covid-19 prompted early retirements and changed work patterns starting in 2020. That’s not seen changing anytime soon.
“This labour shortage has helped feed inflation,” Richmond Fed President Thomas Barkin said last Friday, and with US baby boomers retiring, that’s likely to continue over the long term. Even though the Fed has quickly raised rates, “we have seen labour demand continue to run ahead of supply”, he said.
At the upcoming meeting, Fed officials may also want to highlight their steadfastness on higher rates to lean against Wall Street, which has reacted to the planned downshift with an easing of financial conditions that may be unwelcome. The Fed has been deliberately trying to tighten conditions to reduce demand and ease price pressures.
“Broader financial conditions are getting easier. It’s not clear to me that the Fed’s making a lot of progress.” said Stephen Stanley, chief economist, for Amherst Pierpont Securities. “The Fed has a lot of work to do still to cool the economy off enough and in particular the labor market enough to get to where they want to be on inflation. We’re certainly not there yet.” BLOOMBERG
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