Analysis: Jobs Report Should Ease Fed Fears About Unemployment Falling Too Low

For the last several years, markets have watched monthly employment reports for signs that job gains would be strong enough for the Federal Reserve to gently raise interest rates.

Now, after several rate increases and with unemployment at a 17-year low, Fed officials face the question of whether joblessness might fall so much that they should pick up the pace of tightening to prevent the economy from overheating.

The latest employment report released Friday by the Labor Department doesn’t suggest they need to move more aggressively or slow down. Employers added 148,000 jobs in December, and the unemployment rate was unchanged at 4.1%. Average hourly earnings of private-sector workers rose 2.5% from a year ago, in line with recent monthly readings.

While the pace of job growth was slightly below the monthly average of 171,000 jobs last year, a slower pace probably comforts Fed officials because unemployment has dropped below the level they believe is sustainable over the long run, around 4.6%.

So far, they haven’t had to worry that unemployment is too low because inflation is running below their 2% target. Consumer prices, excluding food and energy items, rose 1.5% for the year ended November, according to the central bank’s preferred gauge.

Fed officials want a tight labor market to push inflation up to 2%, which they see as a healthy level for an expanding economy, but don’t want price pressures to surge out of control. Some worry if the economy gains too much momentum, they would have to raise rates more aggressively, which could derail the recovery.

Fed governor Jerome Powell, who is in line to succeed Fed Chairwoman Janet Yellen next month, said in a speech last June that the continued strength of the labor market “might warrant a faster pace of tightening.”

After holding their benchmark federal-funds rate near zero for seven years, Fed officials have raised it five times since late 2015, most recently in December, to a range between 1.25% and 1.5%. They also penciled in three quarter-percentage point rate increases in 2018 and two more moves in 2019.

The Fed is expected to leave rates unchanged at its next meeting, Jan. 30-31. Before the release of the employment report, the market for federal-funds futures contracts implied traders saw a 73% probability of a rate increase at the central bank’s second meeting of the year, in March, according to CME Group.

Fed officials surely cheer signs the tight labor market is drawing people back to work. The share of adults aged 25 to 54 who are working rose to 79.1% in December, the highest level since July 2008, when the economy was contracting sharply. That is up from a recent low of 74.8% in November 2010, but still below the 80.1% high point reached during the mid-2000s expansion.

So far, strong hiring and stable growth hasn’t translated into big gains in wages or prices, a function of weak productivity growth and possibly a greater level of slack in the labor market than many economists initially believed. Still, in several U.S. metro areas with very low unemployment rates, wages appear to be rising at a stronger clip as labor markets grow tighter.

While the Fed is likely to welcome a pickup in wage growth, such an upturn also would signal that the central bank is entering a delicate policy stage. If officials raise rates too slowly, the economy could overheat. If they move too aggressively, they could trigger a recession.

All of this is playing out in a moment when Washington has approved new tax cuts, which economists expect to boost U.S. growth over the coming two years. Economists at Goldman Sachs Group Inc. last month lowered their forecast for the unemployment rate over the next two years due to the new stimulus. They now see it falling to 3.5% by year’s end, and to 3.3% next year, which would be a level not seen since the early 1950s.
Source: Dow Jones

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