The Fed could raise interest rates more than expected to beat inflation

Monthly wages rose at the fastest pace since January and U.S. employment grew more than expected last month, according to a report released Friday. That will concern Fed Chairman Jerome Powell, who warned this week that weaker labor market conditions and lower earnings growth were needed to cool an inflation rate near a 40-year high. .

Powell and his colleagues, now in their blackout ahead of the meeting, strongly suggested they would downgrade to half a point at their Dec. 13-14 meeting, after four consecutive 75 basis point increases. He also said they will likely need higher rates than they thought in September, when the median forecast called for them at 4.6% next year, up from a current target range of 3.75% at 4%.

“Powell has suggested that we’re not in a spiral of wage growth yet, but that risk is still there,” said Rhea Thomas, senior economist at Wilmington Trust Co. “It keeps this idea in play that they might have to increase the peak rate and potentially keep it in place longer.

Bets on a downgrade to a half-point hike this month were intact after the jobs report and investors saw the likelihood of the same again at the Jan. 31 Fed meeting. to February 31. 1 session also more or less balanced. Prices in futures markets show rates peaking at around 4.9% next year.

Officials will update their quarterly forecasts at the December meeting and could raise their median projection for peak rates next year to 5% or more. St. Louis Fed President James Bullard called for a minimum peak of 5.25% and some analysts, including Diane Swonk, chief economist at KPMG LLP, see rates as high as 5.5%, with the Fed ready to trigger a recession if needed to restore price stability.

Inflation ‘metastasizes’ if left untreated

“Inflation is like cancer: if left untreated, it metastasizes and becomes much more chronic,” Swonk said. “The cure” for higher rates means “2023 will be a tough year”.

Fed officials will receive an additional report on consumer prices ahead of the December meeting and will have another month of data to ponder before meeting again early next year.

Powell said on Wednesday that rising wages would likely be “a very important part of the story” of inflation. While supply chain difficulties seem to be easing for goods, which improves the price outlook in this sector, he said that wages are the most important cost for the service sector, so that working conditions are key to understanding the price outlook on everything from hotels to haircuts.

The jobs report showed average hourly earnings jumped 0.6% in November in a broad-based gain that was the biggest since January and rose 5.1% from a year earlier. Salaries for production workers and non-supervisors rose 0.7% from the previous month, the highest in nearly a year. The pace of wage increases is inconsistent with the Fed’s 2% inflation target.

“The pressures remain in the labor market and if anything is as bad as they have been,” said Vincent Reinhart, chief economist at Dreyfus and Mellon. “They want a little more real restraint given that they believe – or at least Powell believes – that inflationary pressures are deep in the consumer price basket.”

With central bankers aiming for below-trend growth to ease price pressures, the creation of 263,000 jobs last month – leaving the unemployment rate at 3.7% – is the latest evidence that the US economy remains resilient. Growth in the fourth quarter could be 2.8%, well above estimates of what is sustainable over the long term, according to the Atlanta Fed’s tracking estimate.

While Fed leaders suggested it was possible to moderate to 50 basis points this month, they sought to shift investors’ attention to where rates peak based on the magnitude of the movements made at each meeting.

They also pointed to the cumulative impact of past increases and the notion that the policy works with a lag. This has encouraged speculation that they may return to 25 basis points next year to reduce the risk of going too far.

Even so, the latest jobs report may prompt officials to consider another 50 basis points early next year.

“The Fed – and Powell in particular – is very focused on labor market-led sources of inflation and this report will keep it on high alert,” said Thomas Costerg, senior US economist at Pictet Wealth Management. “I think they can continue with another 50 at the next Fed meeting.”

“This labor shortage has contributed to fueling inflation”

The labor force is growing much slower than expected, with 3.5 million fewer workers than expected after Covid-19 caused early retirements and changed work patterns from 2020. This is not expected to change any time soon. .

“This labor shortage has helped fuel inflation,” Richmond Fed President Thomas Barkin said on Friday, and with the retirement of America’s baby boomers, this is expected to continue at long term. Even as the Fed quickly raised rates, “we’ve seen demand for labor continue to outpace supply,” he said.

At the next meeting, Fed officials may also want to underscore their determination to raise rates to build on Wall Street, which has reacted to the expected slowdown with a potentially unwelcome easing of financial conditions. The Fed deliberately tried to tighten conditions to reduce demand and ease price pressures.

“The broader financial terms are getting easier. It is not clear to me that the Fed is making much progress. said Stephen Stanley, chief economist, for Amherst Pierpont Securities LLC. “The Fed still has a lot of work to do to cool the economy and especially the labor market enough to get to where it wants to be on inflation. We are certainly not there yet.

—With help from Rich Miller.

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