January’s jobs data sent a cautionary signal to Federal Reserve officials, economists, and markets.
U.S. employers added 353,000 jobs to payrolls last month, tearing past expectations—but rising paychecks may cast a bigger shadow on the central bank’s plans.
In December, Fed policymakers signaled they believed three interest rate cuts of one-quarter percentage point would be on the table this year. And while Chair Jerome Powell noted Wednesday a March rate cut was unlikely, he did leave the door open for cuts as early as May.
But average hourly earnings rose 4.5% year over year in January, up from the revised 4.3% pace set in December, according to Friday’s data released by the Bureau of Labor Statistics. On a monthly basis, wage growth rose by 0.6%, a marked acceleration from the steady 0.4% pace recorded in the last two months of 2023.
If the Fed does ease monetary policy too soon and wage growth remains sticky, it could stall the progress the central bank has made on tamping down inflation. Fed officials have noted nominal wage growth should be in the 3.5% range to be consistent with a 2% inflation target.
So if wage growth is persistently above that rate and cooling trends have stalled—what does that mean for the Fed outlook?
“There is simply no way that 350,000 job gains in a month is consistent with a further cooling of the labor market,” writes Brian Coulton, Fitch Ratings chief economist. “This elevates the risk that nominal wage growth will not fall back to levels consistent with reaching the inflation target on a sustained basis, particularly as the labor force participation rate refuses to rise any further.”
While the tighter labor market is fueling the bulk of the pay gains, the minimum wage hikes 22 states implemented in January to the tune of $0.45 per hour, on average, also had an impact.
The effect of union strikes and revised labor contracts also cannot be dismissed, says Raymond James chief economist Eugenio Aleman.
“It is clear that union negotiations have impacted the manufacturing sector,” he says, noting data released Thursday by the bureau showed unit labor costs were much higher in the manufacturing sector versus the rest of the economy.
That said, manufacturing is a relatively smaller portion of the U.S. economy. And while employment in manufacturing edged up in January by 23,000, the sector experienced little net job growth in 2023.
Still, the downward trend around wage growth has stalled out in recent months and Friday’s revisions don’t help the picture for the Fed, says Stephen Stanley, chief U.S. economist at Santander. He notes that while January’s significant wage growth acceleration is probably more of a one-off spike, persistently high—and rising—wage growth does raise concerns about overall inflation trends.
“I hold pretty strongly that inflation data over the last six months are overstating the degree to which the underlying trend is falling,” Stanley says.
He adds that economists have been lucky, with a lot of the noisiest categories falling over the last six months and potentially masking stickier underlying factors.
“We’re making progress [on inflation], but not nearly as rapidly as what the headlines would suggest,” Stanley says. “Couple that with what looks to be a pretty steady pace of wage growth over the last six months to a year, and it does raise concerns that getting from where we are now all the way back to 2% may not be as easy as some believe.”
While that lends support to Powell’s refusal to declare victory this week, Moody’s Analytics labor economist Dante DeAntonio believes the situation may not be as concerning as Friday’s data suggest.
“The totality of data still suggests that wage growth is trending in the right direction,” DeAntonio says.
He points to the latest measure from the employment cost index, which on Wednesday showed the smallest wage gain in two years for the fourth quarter of 2023. Wage growth for private industry workers calculated by the ECI peaked at 5.7% in the second quarter of 2022 and consistently slowed to 4.3% at the end of 2023.
Many economists contend the recent bout of strong labor productivity—which rose 3.2% during the fourth quarter—has helped offset the effects of wage growth and reinforce economic growth as the Fed works to dampen inflation.
Another source of optimism is the fact that the quitting storm is over. Labor data from December show the quit rate remained unchanged at 2.2% in December, down from a high of 3% in April 2022.
“Workers are settling into jobs, which is good news in fighting inflation,” says Ron Hetrick, senior economist at Lightcast. “Every time someone quits, an employer has to go find someone else, probably for more money.”
But for now, it is still a wait and see game as to whether inflation, particularly services price pressures, will ease in the face of strong wage growth. Stanley believes Fed officials won’t move on rate cuts until there is more clear progress on the services side of inflation. And even then, Friday’s data likely support a more cautious approach to easing monetary policy.
“What they haven’t really seen yet, to their satisfaction, is a slowing in core services ex-housing,” Stanley says.
The biggest input costs for most services firms is usually labor.
“So the wage situation is important for the underlying inflation picture, and it’s particularly important on the services side,” he adds.
Write to Megan Leonhardt at megan.leonhardt@barrons.com
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