January 31, 2023

The Federal Reserve will face increased urgency in its battle to cool the US economy with sharp rate hikes after the latest batch of labor market data revealed an unexpected acceleration in job growth and strong wage growth.

The data released Friday allayed concerns that the US economy was slowing sharply or already in recession after two consecutive quarters of contraction in production this year. However, it will raise concerns that high inflation will become entrenched as wages continue to rise, requiring even more central bank intervention.

The Fed has already raised its key interest rate from the lowest level of the coronavirus pandemic to a target range of 2.25 percent to 2.5 percent this year, including two consecutive 0.75 percentage point increases in June and July.

Based on the latest jobs report, economists and Fed watchers say the chances of another aggressive upward move next month have increased, although the central bank will continue to closely scrutinize upcoming economic data, including inflation figures expected next week.

“Today’s numbers should allay fears of a recession, but raise concerns that the Fed has a lot more work to do, and we now think a 75 basis point hike in September looks likely. The inflation concerns motivating the Fed will only increase with this jobs report,” Michael Feroli, a senior economist at JPMorgan, wrote in a note on Friday.

“Job numbers have not slowed at all in response to the Federal Reserve tightening. This is a double-edged sword,” added Michael Gapen, chief US economist at Bank of America, noting that while the likelihood of a “short-term recession is lower,” the “risk of a hard landing is increasing.”

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David Mericle, chief US economist at Goldman Sachs, said the report cleared up some “ambiguity” about the strength of wage growth in the US economy, suggesting it didn’t ease as much as the Fed would hope.

“The general message is that wage growth is going sideways at a pace that is probably a few percentage points stronger than what would be compatible with hitting 2 percent inflation,” he said. “The Fed has more to go than we thought today.”

Fed Chair Jay Powell is expected to present his final thoughts on the path of US interest rates and the central bank’s strategy to curb inflation at the annual conference in Jackson Hole, Wyoming, to be held in late August.

At his latest press conference in July, Powell said “another unusually large increase” in interest rates in September “might be appropriate,” but that decision was not made.

“It’s one that we’ll create based on the data we see. And we will make decisions by meeting,” he added.

Movements in the financial markets could also play a role in the Fed’s next move. Traders began to estimate expectations of higher interest rate hikes after the jobs data, predicting that rates will peak at 3.64 percent in March, compared to the 3.46 percent expected prior to the report. Fed fund futures show the probability of a 0.75 percentage point increase in September rose to 67 percent, from 33 percent on Thursday.

While strong job numbers are putting pressure on the Fed, it has been welcomed by the Biden administration as it means a sharp economic downturn is less likely in the run-up to November’s midterm elections.

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It comes as Congress prepares to vote on a $700 billion package of measures designed to curb inflation by raising taxes on big business, lowering the cost of prescription drugs, and cutting the budget deficit. – although it would also boost spending on clean energy incentives to combat climate change.

“This bill is a game changer for working families and our economy. I look forward to the Senate adopting this legislation and passing it as soon as possible,” Biden said Friday.