When unemployment falls, the interest rate rises closer

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New data showing that unemployment is falling and wages are rising is expected to cement – and perhaps even accelerate – the Federal Reserve’s plan to start rate hikes this year to contain high inflation.

The unemployment rate fell to 3.9 percent in December based on data collected over a period largely ahead of the worst of the Omicron-powered virus wave.

Unemployment has peaked at 14.8 percent in April 2020 and had hovered 3.5 percent for months before the pandemic broke out. The fact that it is returning to near normal levels so quickly has led many central bankers to state that the United States is nearing “full employment” even though millions of former workers have yet to return to the labor market.

“This confirms the Fed’s conclusion,” said Diane Swonk, chief economist at Grant Thornton, following the report. “It’s a hot job market.”

There are many signs that there are many jobs, but that a workforce is hard to find: vacancies are high and the percentage of people leaving their jobs has just hit a record. Employers complain that they have difficulty hiring, and a labor shortage has led many companies to cut hours or services.

As a result, employers pay more to keep their employees and attract new applicants. Average hourly wages rose 4.7 percent over the course of the year through December, faster than economists expected in a Bloomberg survey and much faster than the typical pre-pandemic pace of progress, which fluctuated 3 percent.

These rapid wage increases are a signal to Fed officials that people who are looking for and available for work can generally find it – that the job market is what economists call “tight” and that potential workers are relatively scarce – and that wages could begin to feed into prices. When companies pay more, they can also charge their customers more to cover their costs.

Some Fed officials are concerned that rising wages and limited production could help maintain elevated inflation – now at nearly 40-year highs. The combination of a recovering labor market and the risk of price hikes spiraling out of control has led central banks to accelerate their plans to withdraw political aid from the economy.

Fed officials are already curbing the large bond purchases they are using to prop up the economy. Additionally, they estimate they could hike rates three times in 2022, and economists believe those hikes could start as early as March. That would make borrowing for cars, houses, and business additions more expensive, and slow down spending, new hires, and growth.

“It makes sense to get started sooner rather than later,” said James Bullard, president of the Federal Reserve Bank of St. Louis, during a call to reporters Thursday, suggesting that steps could be taken very soon. “I think March would be a definite possibility.”

And officials have signaled that once the rate hikes begin, they could immediately begin shrinking their balance sheet – where they are holding the bonds they bought to fuel growth during the pandemic downturn. This would help raise longer-term interest rates, fuel rate hikes and further curb lending and spending.

According to the job report, economists speculated that the new numbers make an impending rate hike even more likely and that the central bank could even be persuaded to stop its economic support more quickly as wages rise.

“We believe today’s report will help the Fed begin its rate hike cycle in March,” wrote Bank of America researchers. “The economy seems to be operating below maximum employment and inflation remains high.”

Krishna Guha, an economist at Evercore ISI, argued that the combination of rapidly falling unemployment and high wages could even cause central banks to hike rates faster than every three months – the fastest pace of their most recent rate hikes, which lasted from 2015 through to 2018.

“The Fed may need to raise one quarter faster than baseline,” wrote Guha.

New data released next week could add to that pressure: The consumer price index is set to climb 7 percent in the year through December, based on a Bloomberg survey of economists, which would be the fastest increase since June 1982.

The White House is doing everything it can to encourage competition, untangle supply chains and marginally lower prices, but control of inflation rests primarily with the Fed, a fact President Biden underscored at a news conference on Friday.

“I am confident that the Federal Reserve will achieve its twin goals of full employment and stable prices and ensure that price increases do not become permanent,” said Biden.

Investors will have the opportunity to hear for themselves from key Fed officials next week. Jerome H. Powell, whom Mr. Biden has appointed Chairman of the Fed, has confirmation Listen on Tuesday before the Senate Banking Committee. Lael Brainard, now Fed Governor and elected Vice-Chair by Mr Biden, has a hearing on Thursday.

Both are likely to emphasize the unevenness of the recovery and acknowledge that millions of workers remain excluded from the job market due to caregiving duties, virus fears and other pandemic barriers like throughout the downturn.

You will also likely find that December hiring slowed overall: employers created 199,000 jobs, the worst performers of the year as they struggled to find work. And Omicron is at risk of further cut as the November data came before the recent surge in virus cases, which has kept diners in check and shut down live performances.

But at the end of the day, falling unemployment should stay in focus for the Fed as it thinks about its next steps, say economists.

“A rate hike in March seems pretty likely at this point,” said Julia Coronado, founder of research firm MacroPolicy Perspectives. When asked whether the new data provides any overarching insight, she said: “It’s just a tightening labor market. That’s it.”


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