By John Beuerlein, chief economist, Pohlad Companies
The monthly employment report has taken on increased significance due to the Fed’s focus on job growth and inflation in developing monetary policy. The February payroll report released Friday, March 9 by the U.S. Bureau of Labor Statistics showed the largest increase in payrolls in 18 months. February payrolls grew by 313,000 (expected at 200,000), and payroll numbers for the previous two months were revised upward by 54,000. The unemployment rate held steady at 4.1 percent for the fifth consecutive month.
The underlying pace of employment growth has clearly picked up with the six-month average monthly gain rising to a 14-month high of 205,000.
The number in the report that was of most interest, however, was the average hourly earnings. After surprising the markets last month with a strong reading indicating that wages were growing 2.9 percent on a year-over-year basis, the March 9 report restated the January numbers to show a 2.8 percent wage growth rate, and February wages were reported as growing at 2.6 percent year over year.
All of this information (which is subject to revision next month) indicates that labor markets remain strong but that wages aren’t accelerating as feared after the January report. The strong wage growth in the January report was the catalyst for the financial turbulence that occurred during February. Strong wage growth would likely force the Fed to raise interest rates more aggressively than expected in order to keep inflation in check.
The Fed is widely expected to raise the Federal Funds rate to 1.75 percent from 1.50 percent at the March 20-21 meeting, the first meeting with the new chairman, Jerome Powell. The Fed has announced that they expect to raise short-term rates a total of three times in 2018. Strong wage growth that results in higher inflation readings may push the Fed to raise rates four times in 2018, however.
Although the labor market is clearly exhibiting strength as evidenced by this report, coupled with anecdotal reports of labor shortages in many industries, the Fed has been concerned about the inability of the economy to generate more inflationary pressures. With wage growth one of the important components of overall inflation, stronger wage growth is needed for inflationary pressures to become persistent, in the eyes of the Fed.
The discussion at the Fed concerning the pace of interest rate increases, then, hinges on the outlook for inflation. Inflation and inflationary expectations are the biggest determinant of long-term interest rates but also play a significant role in the setting of short-term interest rate policy.
While the U.S. economic expansion has entered its ninth year, it still does not display typical late-cycle characteristics such as significant wage pressures, high inflation or elevated interest rates. U.S. economic vibrancy will be directly linked to the resilience of consumers—and therefore the labor market—for the foreseeable future. A healthy labor market, then, will help to keep recession risks low. The biggest risk to economic growth is an overly aggressive Fed that responds to higher-than-expected inflationary pressures by raising interest rates more than expected.