Why May’s jobs data complicates the inflation picture for the Fed

Federal Reserve officials have signaled they may keep interest rates steady at the upcoming June meeting — pausing after a string of 10 straight rate hikes to give themselves time to see how the economy shapes up. New jobs data released Friday could help inform policymakers as they try to decide whether now is the right moment to take a break.

Unfortunately for central bankers, they created a complicated picture: While unemployment rose and wage growth slowed in May, evidence of the cooling the Fed has been waiting for, actual job gains were much stronger than economists had expected.

Central bankers raised interest rates to a range of 5 to 5.25 percent from last month, sharply up from near zero at the start of 2022. But they have signaled that a pause from raising rates may soon be appropriate so they can consider how the economy absorbs the major policy changes it has already made and the consequences of other developments, including the fallout from the recent banking crisis.

Higher interest rates cool the economy by making it more expensive to borrow to buy a house or finance a car purchase, but it takes time to have the full effect. In response to steeper borrowing costs, companies gradually scale back expansion plans and slow hiring, which then leads to weaker wage growth and a slower economy overall.

This is why labor market data is so critical. They are a referendum on how well policy is working to cool the economy, and they suggest whether inflation is likely to slow. Officials have been concerned that rapid wage growth could prompt companies to continue raising prices quickly as they try to prevent steeper wage bills from eating into profits.

Friday’s labor market data provided both good and bad news for policymakers. Unemployment rose to 3.7 per cent, compared to 3.4 per cent at the previous survey, and wage growth slowed slightly. Still, employers added 339,000 jobs in May, far more than economists had expected and an increase from the previous month.

These conflicting signals – of softening on the one hand and resilience on the other – were partly due to differing results from the two different surveys used in the monthly employment report. But the divided labor market picture could make the Fed’s task of figuring out how to set policy all the more challenging.

“If you zoom out and look at labor market trends, the numbers still tell you there’s a lot of labor market strength,” said Gennadiy Goldberg, a fixed-income strategist at TD Securities who expects the Fed to “skip” and raise rates this month.

“Given this positive surprise in payrolls, I still think the Fed has more room to tighten – they have a tough call ahead in June.”

Some Fed officials have already said they would prefer to hold off on a rate hike in June, giving them more time to see how higher borrowing costs and increased uncertainty combine to constrain the economy. Patrick T. Harker, the president of the Federal Reserve Bank of Philadelphia, said this week that he is “definitely in the camp to think about skipping any increase at this meeting.”

And in a signal that a pause may be coming, a key official stressed earlier this week that taking a meeting away from rate hikes would not mean the Fed is done raising rates altogether.

“A decision to hold the key rate constant at an upcoming meeting should not be interpreted as saying that we have reached the top rate for this cycle,” said Philip Jefferson, a Fed governor who is President Biden’s pick to serve as vice chairman of the institution. , comments in a speech this week.

“If you skip a rate hike at an upcoming meeting, the committee may see more data before making decisions on the extent of further policy tightening,” Jefferson added. The Fed vice chairman is traditionally an important communicator for the institution, someone who broadcasts how core officials think about the policy path forward.

Investors appeared to believe the fresh jobs data could complicate the Fed’s upcoming decision. They increased the likelihood of a rate move this month after the report, based on financial market prices. Yet they still only saw a one-in-three chance of an increase.

Julia Coronado, founder of MacroPolicy Perspectives, said she did not think the strong overall job gain would be enough to dissuade Fed officials from halting their meeting on 13-14. June. The other details in the report — from hours worked to the unemployment rate — confirmed that the economy is cooling, she said.

The big gain in payrolls “is the anomaly here,” she said. “Everything else points to a cooling in the labor market.”

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