After recent economic reports showed that inflation was stronger than expected in January and employers added a larger-than-expected 353,000 jobs in the first month of the year, market participants are beginning to think the Federal Reserve will start cutting rates later than expected.
In this Q&A, Brett House, Professor of Professional Practice at Columbia Business School, examines the influence the latest batch of economic reports may have on the Fed’s next moves.
CBS: What drove such a large jump in the number of US jobs in January? Why do you think this exceeded analysts’ expectations?
Brett House: It’s important to understand that there was a net decline of 2.6 million active US jobs in January’s non-farm payroll (NFP) numbers, rather than an increase. This is typical in January of any year: Manufacturing, retail, and service businesses that hired extra workers for the busy holiday period typically lay off staff in the wake of New Year’s celebrations. The headline gain of 353,000 jobs in January reflected an attempt by the Bureau of Labor Statistics (BLS) to extract the economy’s underlying hiring trends from the holidays’ seasonal noise: The notional gain in jobs indicated that January’s layoffs were smaller than would normally be the case, all other things in the economy being equal.
While this may sound like statistical maneuvering, we should focus less on the absolute value of January's seasonally adjusted hiring number and concentrate more on the directional signal it conveys: The US labor market is humming along much more robustly than we’d expect in the presence of regular seasonal fluctuations and reasonably restrictive financial conditions.
The US economy keeps outperforming against analysts’ expectations because our models imply that the Fed’s relatively high interest rates should be dampening economic activity more than they are. The elevated cost of credit is being offset by sustained demand from strong government spending, the continued rundown by consumers of extra household savings from the pandemic-induced shutdowns, and improvements in productivity that are curbing inflation.
CBS: January saw growth in average hourly earnings accelerate, but growth in average weekly earnings slow. What do these divergent prints say about where the US economy is heading?
House: January employment data are notoriously volatile, subject to particular challenges in stripping out seasonal variations from underlying trends, and often substantially revised, so I would caution against making too much of this print. For instance, the BLS numbers indicate that growth in average weekly earnings has been slowing since mid-2022, at the same time as the average of weekly hours worked has also come down. If average hours worked were incorrectly estimated and were, in fact, higher than reported, then average hourly earnings growth may have slowed rather than sped up.
It’s also worth recalling that the BLS’s own household survey data show that 700,000 fewer US residents were employed in January 2024 than in November 2023. While the US labor market remains solid, these jobs numbers aren’t consistent with a developing wage-price spiral that should prompt the Fed to keep monetary policy tight.
CBS: Higher interest rates typically mean that construction jobs, for instance, suffer. Why do you think hiring remains so strong in this sector?
House: Homebuilding hasn’t been keeping up with new household formation in the United States for over a decade. This has resulted in a shortage of at least a couple million new homes compared with the demand from Americans going out on their own and new immigrants arriving in the country. With the supply of housing consistently running so far behind demand, home prices have remained high and hiring for skilled construction workers has stayed strong even in the face of restrictive real and nominal interest rates.
CBS: Although headline inflation fell from 3.4 percent year on year (YoY) in December to 3.1 percent in January, consensus forecasts had expected it to come down 2.9 percent YoY. Should we be worried that the inflation dragon hasn’t yet been slayed?
House: January’s unexpectedly strong consumer price index (CPI) data lent credence to the view that the so-called last mile of inflation reduction is the hardest — which the Fed itself has previously acknowledged in cautioning that the route back to its 2 percent average inflation target won’t follow a straight line. In fact, price pressures heated up in January, with one-month and three-month CPI inflation rates both accelerating sharply as shelter prices continued to rise.
That said, interpreting January price data requires some caution, for some of the same reasons that augur for reserve in reacting to the month’s employment numbers. Every January, the BLS recalculates its seasonal adjustment factors to reflect price movements from the just-concluded calendar year. These resets can skew seasonal adjustments to January’s numbers in ways that raise the risk of future revisions.
There are also other signs that inflation remains on a broadly cooling trend. The Fed’s preferred price measure, the personal consumption expenditures (PCE) index, notched a 2.9 percent YoY gain in January. Core CPI inflation, exclusive of shelter costs, is running around 2.5 percent on an annualized basis.
CBS: How do the January jobs and inflation reports impact the chances of a rate cut later in 2024?
House: Not much. Financial markets got ahead of the Fed in recent weeks by pricing a rate cut as early as the March Federal Open Markets Committee (FOMC) meeting, even as major high-frequency economic data releases have pointed to continued strength in US economic activity that could imply slightly greater persistence in inflation pressures. January’s NFP and CPI reports bore out this concern, and markets have now completely eliminated pricing for a March cut and pared back pricing for May too.
March was always an ambitious prediction for a rate cut, considering the Fed's need to ensure it has successfully approached its inflation target before easing up on efforts to control price gains. Nevertheless, it’s nearly there, notwithstanding January’s hotter than expected data.
The Fed is just as focused on maintaining the US economy’s soft landing, with positive growth and unemployment rates near historic lows, as it is preoccupied with wringing out the last bit of above-target inflation. With real interest rates still quite restrictive, the FOMC will need to cut rates this year — but it was never likely to do so without also producing updated forecasts that justify the move. March is the first time in 2024 that the FOMC is slated to deliver a revision to its forecasts (i.e., the “dot plot”), which is why markets (wrongly) gelled around a first cut arriving then.
Instead, the FOMC is most likely to deliver its first cut in either June or September when the FOMC will also release its second and third quarterly 2024 updates to its economic projections.
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