January’s employment report came as a big surprise for most economists and further adds to the puzzle of whether the Federal Reserve will be able to avoid plunging the economy into a recession.
Just how big of a miss was it for forecasters? They had predicted the economy would add just 185,000 jobs and the unemployment rate would tick up. But what ended up happening was a surge of more than half-a-million jobs in January and the unemployment rate falling to 3.4%, the lowest level in a couple of generations.
The news is confounding because of how aggressive the Fed has been with hiking interest rates. Conventional wisdom would suggest that the unemployment rate would be going up rather than moving in the opposite direction. It also leaves the central bank in an unusual position regarding rate-hiking because while signs indicate that inflation is meaningfully falling, the Fed is hoping to see some softening of the labor market as part of its inflation-reduction campaign.
The country’s 3.4% unemployment rate is also complicated for those who expect there to be a recession in the coming months, as well as in the smaller “soft landing” camp of Fed watchers who believe Chairman Jerome Powell can guide the economy out of high inflation without triggering a recession.
FED SLOWS ITS RATE-HIKING CAMPAIGN EVEN MORE AS INFLATION STARTS TO ABATE
“If job growth is indeed as strong as the latest data suggests, then it presents a puzzle in light of other data showing a slowdown in economic activity, as well as widespread expectations of slow growth — and perhaps even a recession — in 2023,” said Preston Caldwell, chief economist at financial services firm Morningstar.
It is worth noting that one major caveat to the excessively hot jobs report is that it might be a bit overblown. January’s report is the first of the new year and includes seasonal adjustments and revisions to past data, as well as updated population controls. That could muddle the data and mean that the headline number is not quite as dramatic as it suggests.
“Still, we can’t completely write off a job gain of 517,000 in January. Seasonal quirks aside, the data still show a labor market that’s too tight as the Fed tries to get inflation back to 2% and leaves the [Fed] on track to raise rates at least once more this cycle, with the risk of more rate hikes beyond that,” said economists from Oxford Economics in a note.
After conducting the most hawkish monetary policy in four decades last year, the Fed has started to take its foot off the gas. Following a two-day meeting this week in Washington, the central bank announced that it would hike its interest rate target by just a quarter of a percentage point, its most modest hike since March last year. The move comes after the Fed conducted a half-point hike in December and a barrage of enormous 0.75-point increases before that.
That is because a bevy of reports for December released last month showed that inflation, while still high, is coming down. For example, the consumer price index fell to 6.5%, and the personal consumption expenditures price index, which is one the Fed closely watches, fell to 5% from a high of 7% in June. And producer wholesale prices slowed to 6.2%.
All of those reports show that rate hikes are filtering through to the broader economy and giving hope to investors that the Fed will begin winding down its tightening sooner rather than later. Before Friday’s jobs report, most investors expected another mild rate hike at its March meeting. More than 17% felt as though the Fed might not hike at all in March, according to CME Group’s FedWatch tool, which calculates the probability using futures contract prices for rates in the short-term market targeted by the Fed.
That has now changed. After Friday’s jobs report, more than 99% of investors foresee a rate hike in March, and a few even predict a more aggressive half-percentage point increase. Additionally, while on Thursday, nearly 60% felt as though the Fed would forgo a rate hike at its May meeting, more than 60% now predict that interest rates will rise again following that huddle.
On the recession front, January’s jobs report can be read with both hope and some pessimism. A soft landing would entail inflation cooling, while GDP growth and employment would not meaningfully suffer. And because inflation has been falling while the economy has weathered the blows of the Fed’s rate hike, some are taking it as a sign the tight labor market will cushion the economy amid the Fed’s campaign.
“Net, net, the economy is further away from recession than ever with over half a million new payroll jobs to start the new year off right. This is one of the days where economists don’t pick up the phone because they simply do not know what to say. All those purchasing managers indexes and surveys of plugged-in CEOs can be thrown in the rubbish because 517,000 more jobs means there is no recession coming later on this year,” remarked Chris Rupkey, chief economist at FWDBONDS, after the Friday morning release.
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But rate hikes have the natural effect of dampening the economy. So if the January report causes the Fed to raise rates by even more or hold its tightened stance longer, it could end up causing harm to the economy down the road. Many economists still foresee a recession coming, but Friday’s news has surely added to the uncertainty of the current economic landscape.
“Our base case is still recession likely toward the latter part of the year,” said Andrew Patterson, senior economist at Vanguard. “One report is not indicative of a trend, but certainly if we continue to see upside surprises, our baseline is up for discussion. This does increase the marginal probability of a soft landing.”
