By Howard Schneider
WASHINGTON (Reuters) -An historically low U.S. unemployment rate and rising wages will likely keep the Federal Reserve on track to raise interest rates by another quarter of a percentage point next month, as risks of a financial crisis ease while concern about inflation remains high.
U.S. job growth is slowing, something Fed policymakers have anticipated as they raised borrowing costs. But the economy still added 236,000 jobs in March, and has averaged gains of 345,000 per month during the first quarter, well above the level the central bank sees as consistent with its 2% inflation goal.
The unemployment rate fell to 3.5% last month, from 3.6% in February, even as the labor force grew by about half a million people and the participation rate rose slightly. Average hourly wages rose 0.3%, slightly faster than the month before.
The latest jobs report offered the last broad glimpse of the labor market that Fed officials will receive before their May 2-3 policy meeting, and marks another step towards refocusing debate from a potential crisis spurred by the collapse of two regional banks back to their effort to curb high inflation.
Investors in contracts tied to the Fed’s benchmark overnight interest rate added to bets that rates will keep rising, with a quarter-of-a-percentage-point increase next month now given a nearly two-thirds probability.
“Despite weakening in employment readings in the run-up to the non-farm employment report, employment growth has not yet collapsed though there are visible signs of continued moderation,” Kathy Bostjancic, chief economist at Nationwide, wrote shortly after the report was released.
Bostjancic said the Fed overall would be pleased by the data, though she added that it “still is supportive of another rate hike in May – which we think could be the last for the tightening cycle. Followed by a long pause.”
In a possible further sign of easing inflationary pressures, the pace of wage growth on a year-over-year basis declined to 4.2% in March, from 4.6% in the prior month, continuing a recent downward trend.
Economists polled by Reuters had expected a gain of 239,000 jobs in March, with hourly wages seen rising at a 4.3% annual rate and the unemployment rate remaining at 3.6%, a level seen less than 20% of the time since World War Two.
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%-3% range seen by Fed policymakers as consistent with their goal of a 2% annual increase in the Personal Consumption Expenditures price index.
The PCE price index was rising 5% annually as of February, or 4.6% when volatile food and energy prices were excluded, too high for the Fed’s liking and with improvement coming only slowly in recent months.
Ahead of the report, Gregory Daco, chief economist at EY Parthenon, said he expected it would show that “labor market tightness will remain a feature of this business cycle,” and prompt the Fed to keep raising rates.
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%, 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 labor 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 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.” The average work week fell in March to 34.4 hours, from 34.5 hours in the prior month.
Payroll provider UKG said shift work among its sample of 35,000 firms fell 1.6% 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 failures of Silicon Valley Bank and Signature Bank (OTC:).
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 U.S. 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.”
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