The Fed's Dilemma

Chief Economist Scott Brown discusses current economic conditions.

The November Employment Report was a mixed bag. Nonfarm payrolls rose less than anticipated, but the unemployment rate fell sharply. The shortfall in payrolls (relative to expectations) likely reflects the usual noise in the monthly data, it might reflect difficulties in hiring, but it certainly doesn’t reflect weak labor demand. The plunge in the unemployment rate suggests that tight labor markets are an issue – even as payrolls remain 4.1 million (2.7%) below where they were in February 2020. Fed Chair Powell testified that “it now appears that factors pushing inflation upward will linger well into next year.” In addition, “with the rapid improvement in the labor market, slack is diminishing, and wages are rising at a brisk pace.” Together with the broadening of price increases across sectors, the Fed will taper faster and raise rates sooner than was anticipated earlier.

The first thing to do when analyzing the job market data is to ignore the news reports. Headlines: “Hiring Slowed (WSJ); “Hiring was a bust” (NPR); “Companies were growing cautious” (NYTimes). What nonsense.

Prior to seasonal adjustment, the economy added 778,000 jobs last month, well above a typical pre-pandemic November. Retail added fewer jobs than usual, although the sector had added a lot of jobs over the three previous months and couriers (package deliveries) added more than in past Novembers. The three-month average for private-sector payrolls was 429,000, which is strong. Once again, payrolls for the two previous months were revised higher (+82,000), which is what we normally see in a strong job market.

Scott Brown
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The unemployment rate sank to 4.2% from 4.6%, even as labor force participation finally picked up (61.8%, vs. 61.6% in October, little changed over the 12 previous months) – participation averaged 63.2% in 4Q19. The demographics (an aging population) implies that participation should be trending lower over time, but there is still a big gap relative to where we were before the pandemic. Early retirements and dependent care issues have been factors. There are some early signs of un-retirements (think those in their late 50s or early 60s), but childcare remains a significant issue (less available and more expense than before the pandemic).

Average hourly earnings rose 0.3% in November (+4.8% y/y). For production workers, the increase was 0.5% (+5.9% y/y). These aren’t reliable gauges of labor costs, but the direction is right: higher.

For the Fed, tight labor markets aren’t a concern by themselves. But in the current environment, with price increases broadening across sectors (in sharp contrast to the narrow inflation spike in the spring), the tight labor market can be expected to compound inflationary pressures. Fed officials, including Chair Powell have signaled an openness to accelerating the tapering of asset purchases. We are still short of making up the ground lost in nonfarm payrolls during the pandemic and are well below the pre-pandemic job trend. Those on the lower rungs of the economy have fared the worst and are slower to recovery, but conditions will get much worse if the Fed doesn’t act to get inflation back down. There is no easy path here.