The Fed's Fight Against Inflation Looks Harder Now

(Bloomberg Opinion) -- If anyone had doubts that the Federal Reserve will start raising interest rates at its next policy-making meeting in March, the latest jobs report should put them to rest. The relevant question now is how much further might the Fed need to go to keep a strong economic recovery from fueling excessive inflation.

Payroll gains in January exceeded even the most optimistic forecasts, suggesting that the economy weathered the surge in the Covid-19 omicron variant largely unscathed and had much more momentum toward the end of last year than previously thought. Nonfarm employers added an estimated 467,000 jobs in January, while upward revisions to earlier months brought the three-month average gain to 541,000 jobs. Treasury yields climbed on the news, and stocks were uneven.

The payroll growth and revisions help resolve a conundrum presented by the previous two months' employment reports, in which smaller-than-expected payroll gains in the Labor Department's survey of businesses contrasted with larger gains in the separate survey of households. The household survey (adjusted for population controls) now shows a three-month average gain of 490,000 jobs.

So if the economy is doing so well, what does that mean for the Fed? As of its December policy-making meeting, the median forecast among Fed officials was remarkably benign: They expected year-over-year inflation to subside to 2.6% as the central bank increased its short-term interest-rate target from near zero to a still-accommodative level of about 1%. Since then, though, the Fed's preferred measure of inflation has remained well above its 2% target — at 4.85% for December. And the latest jobs report showed average hourly earnings up 5.7% from a year earlier — raising the risk of an upward spiral in which wage and price growth reinforce each other.

Markets have already moved well beyond the Fed's forecast: Eurodollar futures on Friday suggested a federal funds rate of about 1.6% at the end of this year, up from less than 1.5% on Thursday. This indicates that the Fed will have to increase rates much more this year than officials were forecasting in December, possibly including some 50-basis-point hikes. The markets' reaction makes sense: Judging from the jobs report, the Fed is facing a tougher fight with inflation.

More From Other Writers at Bloomberg Opinion:

U.S. Must Fix Talent Recession to Beat China: Adrian Wooldridge
Let the Global Rate-Hike Arms Race Begin: Daniel Moss
Fed Knows What It Needs to Do. Now Comes Hard Part: Bill Dudley

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mark Whitehouse writes editorials on global economics and finance for Bloomberg Opinion. He covered economics for the Wall Street Journal and served as deputy bureau chief in London. He was founding managing editor of Vedomosti, a Russian-language business daily.