The Labor Market Fights the Fed

The labor market is putting the Federal Reserve to the test.

Fed Chairman Jerome Powell and his fellow central bank officials have asserted many times over the past several weeks that the next interest rate decision was an open question that would be resolved by the incoming information about the path of the economy. The next step was not pre-determined, they claimed, but was “data dependent.”

It’s been clear, however, that many on the Fed—including the chairman—would prefer to pause at the meeting of the Federal Open Market Committee a week after next. One of their big challenges has been trying to convince markets not to interpret a pause as a prelude to cuts. Fed Governor Christopher Waller used the phrase “skip” to refer to the idea that the Fed could hold rates steady at the next meeting and then resume hiking at the meeting after that.

It has been difficult to persuade markets of this because history suggests that when the Fed stops raising rates, the next move is typically a rate cut. There is good reason for this. If the Fed is not convinced that the economy is cooling enough to move inflation toward its target, the logical move is to keep raising rates. If the Fed is convinced that inflation is moving to the target, why would it signal further rate hikes are still to come? In other words, there’s an odd inconsistency in planning both a pause and indicating that further hikes are probably required.

The official rationale for the pause seems inadequate. Fed officials say that monetary policy acts with long and variable lags, a paraphrase of a lesson from Milton Friedman. That’s true, but it is hard to see how much could be learned from a single month’s pause or even a few months of holding rates steady. Is there really that much new information expected after the June meeting? In other words, if you are going to hike in July, why not hike in June?

This has been one of the more serious problems with the Fed’s claim that each meeting’s rate decision would be data-dependent. There is not that much data that comes in between each meeting to justify a policy one way or another. Instead, it is the long-term trend in various data series that should influence policy.

Job Creation Is Too Hot to Justify a Pause

The May jobs numbers present the Fed with a serious challenge. The Labor Department said the economy added 339,000 workers to business payrolls in May, far more than expected. What’s more, job growth accelerated, indicating rising demand for workers. The already very hot jobs figures from the prior two months were also revised up by a total of 93,000.

Do not forget that jobless claims have gone sideways for the past six weeks or so, indicating that businesses are no longer shedding workers at an accelerating pace. Job openings jumped back above 10.1 million in the latest Job Openings and Labor Turnover Survey. Construction spending increased. Inflation, as measured by the personal consumption expenditure price index, moved up, with both headline and core inflation increasing on a month-over-month and a year-over-year basis.

If the Fed is truly data dependent, it will hike at the next meeting. A failure to hike will cast doubt on the credibility of the Fed’s commitment to making policy based on incoming data. It’s possible that the Fed could attempt to pause or skip hiking while delivering a super-hawkish statement, economic projections, and press conference. That would be putting a lot of stress on the ability of rhetoric to outweigh actual policy.

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Forget the ‘She-Cession’

It was not that long ago that the business press was full of stories about the possibility that the next downturn would be a “she-cession,” meaning a recession that would hit women workers the hardest. What has actually happened is exactly the opposite. The unemployment rate among women is 3.6 percent, near the multi-decade low of 3.3 percent and below the 3.7 percent rate for men. The labor force participation rate for prime-age women hit an all-time high of 77.6 percent.