Fed refocuses on job market as financial risks ease and inflation remains high

Federal Reserve officials counting on slower US job growth to help them in their fight to lower high inflation will receive key employment and wage data on Friday, the last such download before their next interest rate decision in early May.

Economists anticipate what from the Fed's perspective will be a middling result for March, a month marred by the largest bank failures since the 2007-2009 financial crisis, events that for a brief time at least shifted policymakers' main attention from inflation to financial stability.

With the worst-case outcomes for the financial sector appearing to have been avoided, for now at least, the focus is returning to the real economy, including employment and wage growth seen likely to remain above what is considered consistent with the Fed's 2 per cent inflation target.

The details, such as expected tepid growth in manufacturing jobs and fewer industries adding jobs at all, may point to a deepening sense among businesses that the economy is slowing and consumer demand weakening, developments that could help ease the pace of price increases.

But the headline numbers may give less comfort to the US central bank. Economists polled by Reuters expect a gain of 239,000 jobs in March, with hourly wages rising at a 4.3 per cent annual rate and the unemployment rate remaining at 3.6 per cent, a level seen less than 20 per cent of the time since World War Two. The Labor Department is due to release the report at 8:30am EDT (1230 GMT).

By comparison, payroll growth in the decade before the Covid-19 pandemic averaged about 180,000 per month, and wage growth remained close to the 2 per cent-3 per cent range seen by Fed policymakers as consistent with their goal of a 2 per cent annual increase in the Personal Consumption Expenditures price index.

The PCE price index was rising 5 per cent annually as of February, or 4.6 per cent when volatile food and energy prices were excluded, too high for the Fed's liking and with improvement coming only slowly in recent months.

Gregory Daco, chief economist at EY Parthenon, anticipates job growth may have dropped as low as 150,000 for March, but other data, including a still-high level of job openings, indicate that "labor market tightness will remain a feature of this business cycle," he wrote. That should keep the Fed on track to raise its benchmark overnight interest rate by another quarter of a percentage point at its May 2-3 meeting.

Still hot?

The question now is how long that business cycle might last, and whether the seeds of a serious slowdown are taking root.

The median unemployment rate projected for the end of 2023 by Fed officials at their March meeting was 4.5 per cent, implying a comparatively steep rise in joblessness that in the past would indicate a recession was underway.

Fed officials would never say their aim is to cause a recession. But they've also been blunt that, as it stands, there are too many jobs chasing too few workers, a recipe for wage and price increases that could start to reinforce each other the longer the situation persists.

"The labour markets still remain quite, I would say, hot. Unemployment is still at a very low level," Boston Fed President Susan Collins said in an interview with Reuters last week. "Until the labor markets cool, at least to some degree, we're not likely to see the slowdown that we probably need" to lower inflation back to the Fed's target.

Change, however, may be coming.

Daco noted the 0.3 per cent decline in the average number of weekly hours worked in February, a statistic he says bears watching for evidence of "a more concerning labor market slowdown."

Payroll provider UKG said shift work among its sample of 35,000 firms fell 1.6 per cent in March, a non-seasonally adjusted figure that Dave Gilbertson, a vice president at the company, said indicated overall job growth that was positive but not "as overheated as it has been." Job gains in January and February were larger than anticipated and produced a brief moment when Fed officials thought they might have to return to larger rate increases, a sentiment that died after the recent bank failures.

Economists at the Conference Board, meanwhile, said a new index incorporating economic, monetary policy, and demographic data showed 11 of the 18 main industries at modest-to-high risk of outright layoffs this year.

Conference Board economists have been bearish in contending that a recession is likely to start between now and the end of June, though "it could still take some time before there are going to be widespread job losses," said Frank Steemers, a senior economist at the think tank.

Eye on services

Some of that may be starting.

The Labor Department on Thursday unveiled revisions to its measure of jobless benefits rolls showing that more than 100,000 additional people have recently been receiving unemployment assistance than previously estimated. Moreover, outplacement firm Challenger, Gray & Christmas said the roughly 270,000 layoffs announced this year through March were the highest quarterly total since 2009, outside of the pandemic.

For the Fed, however, that is just one part of the puzzle. How "slack" in the labor market links to lower inflation may depend on where job growth slows, and over what timeline.

New research from the Kansas City Fed suggested the process may prove stickier than expected because the service sector industries currently driving wage growth and inflation are the ones that are least sensitive to changes in monetary policy.

If industries like manufacturing and home building follow familiar patterns as the Fed raises interest rates, credit gets more expensive and demand and employment slow. But the service industries that are responsible for most US economic output are more labor-intensive and less sensitive to rate increases, Kansas City Fed economists Karlye Dilts Stedman and Emily Pollard wrote.

"The services sector, in particular, has contributed substantially to recent inflation, reflecting ongoing imbalances in labor markets where supply remains impaired and demand remains robust," they wrote. "Because service production tends to be less capital intensive and services consumption is less likely to be financed, it also tends to respond less quickly to rising interest rates. Thus, monetary policy may take longer to influence a key source of current inflation."

• Business