Fed’s Urgency for Steep Rate Hikes Lessens After Wage Gains Cool

(Bloomberg) -- Jerome Powell's push to limit the Federal Reserve's interest-rate liftoff this month to a quarter percentage point was bolstered by unexpectedly stagnant wages amid strong hiring seen in February's jobs report.

While employers added 678,000 to payrolls and unemployment fell to 3.8%, average hourly earnings were little changed from January. That's a setback for workers, but it suggests U.S. central bankers aren't facing an immediate wage-price spiral similar to the 1970s, which reduces the urgency to take bolder steps toward curbing hot inflation. 

The Fed chair told lawmakers this week that he backs a quarter-point rate hike at the Fed's March 15-16 meeting, less than the half-point move some Fed officials have suggested. He also stressed policy makers will move carefully due to uncertainty created by the Russian invasion of Ukraine, as they commence a series of rate hikes to confront the hottest inflation in 40 years.

“This report is comforting for the Fed,” said Julia Coronado, founder of the research firm MacroPolicy Perspectives. “This gives them a lot of scope to pursue a steady approach to removing accommodation. There is clearly no evidence of a wage-price spiral -- if anything, wages are moderating.”

The yield on two-year U.S. Treasuries, which are closely tied to expectations for Fed rates, fell to 1.46% following release of the employment report and stood at 1.47% at 1:57 p.m. in New York.

Bets in futures markets price around 140 basis points of tightening this year, starting with a quarter-point move this month, which would mark the first rate increase since 2018.

While wage growth fell short of all forecasts in a Bloomberg survey of economists, the rest of the report proved exceptionally strong. The payroll gain was the biggest since July, and the size of the workforce rose by 304,000.

“This report is a good one for the Fed in that it shows there is a return to the workforce going on which could reduce wage pressures over time,” said Michael Gapen, chief U.S. economist at Barclays Plc. While the Fed will need to raise rates gradually this year, “it should throw some cold water on the inflation-is-out-of-control argument.”

There are now some 600,000 fewer workers in the labor force than before the pandemic. In other words, some 7.6 million Americans have returned to the workforce since April 2020. Increasing the supply of workers will likely help ease wage pressures to some extent, but American demand has also increased. Total inflation-adjusted consumer spending is well above pre-pandemic levels.

“Fed leadership views it as a stay-the-course report,” said Roberto Perli, head of global policy research at Piper Sandler. “Certainly it doesn't call for more than 25 basis points in March, or even later.  The ongoing increase in participation makes it less likely that the labor market would become excessively tight and contribute to further increases in inflation.”

What Bloomberg Economics Says...

“After Fed Chair Jerome Powell all but assured markets that a 25-bps rate hike is in the cards at this month's FOMC meeting, the surprisingly hot February jobs report will do little to change that trajectory.”

-- Anna Wong, Yelena Shulyatyeva, Andrew Husby and Eliza Winger, economists

For the full note, click here

Chicago Fed President Charles Evans told CNBC in an interview after the data hit that “it is good news. It doesn't really change anything that Chair Powell was sort of pre-positioning the Fed for the other day.”

Evans, who has been one of the more dovish U.S. central bankers, also said the Fed should raise rates toward 2% by year-end, implying seven quarter-point hikes from current levels near zero, though he did say that it might not need to be that many.

Fed officials frequently caution that any single report shouldn't be overemphasized as a guide to policy, and economists cited a number of reasons to be wary in interpreting the report's implications for monetary policy.

The news could well take a different turn next week with the release of February's consumer price report, which could show an acceleration from 7.5%, which was already the highest rate in four decades.

While “incrementally positive” for the Fed, the overall picture of concern for inflation becoming embedded in the economy amid a roaring labor market remains, said Aneta Markowska, chief financial economist at Jefferies LLC. 

“We are on track to exhaust all labor market slack by June, and demand for labor is massive, so I don't see how workers do not hold on to their pricing power,” she said. “If I was at the Fed, I would still worry that this is going to feed into wages and inflation expectations.”

Powell, in his congressional testimony, emphasized uncertainty about the outlook for the economy and inflation, citing the Russian invasion as one significant risk. Higher interest rates and less fiscal stimulus are likely to contribute to a cooling off of the economy and reduction of inflationary pressures as supply disruptions ease, he said.

“I think that it is more likely than not that we can achieve what we call a soft landing,” the Fed chief told lawmakers. “They are far more common in our history than is generally understood.”

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