Jobs report shows Fed tightening still a work in progress

By Howard Schneider

WASHINGTON (Reuters) -After a drop in job vacancies, a dip in rental costs and signs of growing consumer caution seemed to show the Federal Reserve’s strict monetary medicine beginning to kick in, a strong September jobs report has left policymakers still waiting for clear signs their efforts to cool the economy are working.

The Labor Department’s report, which showed a gain of more than a quarter of a million jobs, a drop in the unemployment rate, and continued strong wage growth, points to a job market U.S. central bank officials will continue to see as out of line with declining inflation.

In comments on Thursday in advance of the jobs report, Fed Governor Christopher Waller said the expected payrolls gain of around 260,000, well above the pre-pandemic norm, would not “alter my view that we should be focused 100% on reducing inflation.”

Nonfarm payrolls grew by 263,000 last month.

Traders in contracts tied to the Fed’s policy rate boosted bets the central bank will hike its benchmark overnight interest rate by three-quarters of a percentage point for the fourth consecutive time at its Nov. 1-2 meeting.

“They’re going 75 (basis points) because that unemployment rate is going to bother them. The job growth is slowing, but that doesn’t matter. In their mind, we’re still at full employment if not through it,” said Joseph Lavorgna, chief U.S. economist at SMBC Nikko Securities in New York.

In projections issued at the end of the Sept. 20-21 policy meeting, Fed officials at the median expected the unemployment rate to rise to 3.8% by the end of the year, and considered 4% the rate roughly consistent with stable inflation.

The unemployment rate dropped to 3.5% last month from 3.7% in August, partly due to a decline in the number of people looking for work. That dealt a blow to Fed hopes that “labor supply” would improve and help reduce the pressure on businesses to raise wages.

Average hourly earnings grew at a brisk 5% pace on an annualized basis last month.

Like Waller, other U.S. central bank officials have remained adamant that inflation is their prime focus, and, even as they cite what Atlanta Fed President Raphael Bostic this week called “glimmers of hope,” they say they are determined to slow the pace of price hikes even at the risk of rising unemployment and financial stress.

“We are still decidedly in the inflationary woods, not out of them,” Bostic said on Wednesday after noting that some recent data had broken in the Fed’s favor.

Those “glimmers” may show the impact of Fed rate increases beginning to be felt beyond financial market volatility and in the real economy where prices are set.

Rents, a major component of the consumer price index, declined in the three months from July through September, according to a recent report from Apartments.com, reversing a year and a half of strong growth.

Consumer spending in August barely grew after adjusting for inflation, and recent census surveys have shown 40% of people struggling to pay bills – and perhaps ready to tighten their wallets in a step that could slow demand and ease prices.

Job vacancies in August dropped by 1.1 million, the largest decline outside the onset of the coronavirus pandemic and a trend, if continued, that would fit a central piece of the Fed’s narrative for how inflation could be brought down without workers paying too steep a price.

The hope is that hiring can continue even as the pressure for higher wages eases, with companies trimming their employment plans without resorting to layoffs.

GLOBAL REPERCUSSIONS

The Fed had not raised rates by 75-basis-point increments since the early 1990s, but pivoted when the preferred measure of inflation spiked in the spring to more than triple the central bank’s 2% target. The credit tightening underway now is the fastest since the 1970s and early 1980s.

The repercussions have been global – a soaring dollar, rising concern of a worldwide recession, signs of stress in some financial markets, and calls for the Fed to at least slow the pace of upcoming increases in borrowing costs.

The rhetoric of Fed officials has remained strict so far, with promises to remain “resolute” and to “keep at it” until inflation is falling, and little sense that concerns about global financial conditions or market volatility were causing them to rethink the game plan.

In remarks on Thursday that referenced falling rents and job vacancies, Fed Governor Lisa Cook said she still needed to see “inflation actually falling,” while Minneapolis Fed President Neel Kashkari said the bar to any policy change is “very high” at this point.

In a recent look at the globally important market for U.S. Treasury securities, Piper Sandler analysts Roberto Perli and Benson Durham said that even if there were signs of “illiquidity,” trading would have to become “dysfunctional” for the Fed to react.

“Illiquidity will not sway the Fed; dysfunctionality could,” they wrote. “However, the market is not dysfunctional; Yields still move in the direction they should given the macro outlook,” particularly the uncertainty about inflation.

Policymakers will get another key bit of data to digest next week when the Labor Department releases its Consumer Price Index report for September.

Economists polled by Reuters expect core consumer inflation, stripped of the most volatile food and energy components, actually rose last month, with prices forecast to increase at a 6.5% annual rate versus 6.3% in August.

Harvard University economics professor Karen Dynan, in a forecast prepared for the Peterson Institute for International Economics, said that to control inflation the Fed would need to raise the benchmark overnight interest rate perhaps a percentage point higher than policymakers themselves expect, into the mid-5% range, likely triggering a mild recession and a half-percentage-point contraction in gross domestic product in 2023.

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