The FOMC and the Labor Market

by Scott Brown of Raymond James, 11/8/21

Chief Economist Scott Brown discusses current economic conditions.

As was widely expected, the Federal Open Market Committee announced the tapering of its monthly pace of asset purchases. The criteria for the lift-off in short-term interest rates is more stringent, but as Chair Powell admitted in his press conference, reaching full employment by the second half of next year is “certainly within the realm of possibility.”

Nonfarm payrolls rose more than expected in October, up +531,000, with a net upward revision of 235,000 to August and September (leaving the three-month average at +443,000). The economy added 1.558 million jobs prior to seasonal adjustment (+579,000 in education, +218,500 in retail trade, +177,600 in temp help, +97,300 in transportation and warehousing). Hiring in education was less than a typical October, which translates to a 48,000 seasonally adjusted decline. Leisure and hospitality added 28,000 before adjustment, up 164,000 after adjustment. In addition, the birth/ death model, which forecasts job gains in new businesses (unobservable to the BLS), added 363,000 to the unadjusted total (same as a year ago). There’s a lot of noise in the adjustment payroll figure (statistic uncertainty, seasonal adjustment issues, etc.), but the underlying trend in payroll growth remains strong (a +666,000 average for the last six months). Note that upward revisions to previous figures are the norm in a recovery.

The unemployment rate fell to 4.6%, from 4.8% in September and 6.9% a year ago. However, labor force participation was unchanged at 61.6%, the same level as a year ago. A tight labor market and higher wages should pull people off the sidelines and back into the workforce. Increased participation may come over time, but there are limited signs of that so far. Early retirees are unlikely to return. Dependent care remains a critical issue (childcare is more limited and more expensive than before the pandemic). One way to increase labor force participation is to offer incentives for workers not to exit.

Average hourly earnings rose 0.4% in October, up 4.9% y/y, but these figures are not the best measure of labor costs (the Employment Cost Index for private industry workers, released October 29, accelerated to 4.1% y/y in September). The pandemic was like a splash of cold water in the face to many low-wage workers. They see friends and relations getting better jobs and are more likely to seek (and get) higher wages at new jobs (stay, and you may receive a minimal cost-of-living adjustment).

Is his press conference following the FOMC meeting, Fed Chair Powell said that there is no evidence of a wage-price spiral (higher wages leading to higher prices leading to higher wages, and so on). The increase in inflation this year is primarily due to supply and demand imbalances. “Bottlenecks and supply chain disruptions are limiting how quickly production can respond to the rebound in demand in the near term,” Powell noted, “as a result, inflation is running well above our 2% longer-run goal.” The supply constraints “have been larger and longer lasting than anticipated” and the Fed’s baseline expectation is that “supply bottlenecks and shortages will persist well into next year.” The Fed’s policy tools cannot ease supply constraints. Fed policymakers (and most economic forecasters) believe that the economy will adjust to supply and demand imbalances over time, “and as it does, inflation will decline to levels much closer to 2%.” Still, if the Fed were to see signs that inflation and inflation expectations were moving “materially and persistently” beyond levels consistent with the Fed goal, “we would use our tools to preserve price stability.”