US on the road to 1950s-style unemployment, but it may only be a pit stop

Washington

THE last time the US unemployment rate fell below 3 per cent, as one Federal Reserve official has predicted it will this year, the Korean War was nearing its end and a recession that saw legions of workers lose their jobs was just around the corner.

While the circumstances were unusual, it nonetheless presented a now-familiar pattern - a falling unemployment rate eventually giving way to recession - that current Fed officials will be challenged to avoid as they try to slow the fast pace of inflation without wrecking an expansion that is delivering strong gains for workers.

Emblematic of the current confidence in the job market's strength, St. Louis Fed president James Bullard last week said he expects the US unemployment rate to fall below 3 per cent this year. That flashback to the 1950s in itself would be a warning for some economists.

Such a low unemployment rate is "a red flare" that the economy is overheating, with fast price and wage increases that are unavoidable and the US central bank pushed to be more aggressive, said Tim Duy, a University of Oregon professor and the chief economist of SGH Macroadvisers. "I don't see where there is a good way out" that tames inflation without triggering a recession and the associated jump in unemployment, he added.

It's a trade-off - of jobs for price control - the Fed thought had become less relevant.

In the decade before the onset of the coronavirus pandemic, unemployment drifted towards 3 per cent without triggering inflation, and policymakers felt that showed the economy could put far more people to work than previously thought with prices remaining stable.

The pandemic has rekindled that debate and raised doubts about whether inflation, the work choices of Americans, even the global economy overall, will follow the patterns that existed before 2 years of mass infection, fear and lockdowns.

In 2019, for example, the unemployment rate hovered around 3.5 per cent while inflation struggled to hit the Fed's 2 per cent target.

Going into 2022, amid a global tangle of supply chain bottlenecks, workers' reluctance to take jobs, and the ongoing pandemic, the unemployment rate was about 4 per cent, businesses wanted far more workers than were willing to take a job, and inflation was nearly triple the Fed's objective.

US central bank officials still think they can avoid a recessionary "hard landing" as they begin what Fed chair Jerome Powell says will be a steady removal of the low interest rates and other measures meant to help the economy through the pandemic. Policymakers at this point support that approach, with the first rate hike widely expected to come next month.

The Labor Department's jobs report for January released last Friday showed what the Fed is grappling with in an era when neither prices or employment - the two pillars of its policy mandate - are behaving as expected.

Many analysts forecast that the economy had actually lost jobs last month amid a record surge in Covid-19 cases and as businesses scaled back either out of caution or because their employees were sick.

The report, however, showed employers added 467,000 jobs, and wages jumped, a sign of the pressures building in the economy despite the jump in infections driven by the Omicron variant.

A surprise to the other side - labour force participation rose and the unemployment rate actually edged up a tenth of a percentage point, a trend that if established could work in favour of a less aggressive Fed.

But as it stands, "we have to take the numbers at face value, and they paint a picture of a labour market on fire", wrote Jefferies economists Aneta Markowska and Thomas Simons, with the Fed likely heading towards "a more sustained tightening cycle anda higher terminal rate". REUTERS