Enough labor market progress for the Fed?
Updated: Jul 26
Tight US labor markets—shortages of available workers—have been cited frequently by Federal Reserve officials as a reason that interest rates must be pushed higher to reduce inflationary pressure. While healthy employment levels are good for employees and the overall economy, persistent excess demand for labor can drive up wages too rapidly. This raises business costs, which may be passed through into higher consumer prices. Recently I discussed two of the most frequently publicized indicators. In advance of this week's meeting of the Federal Open Market Committee (FOMC), what can we say about current labor market conditions if we take a broader look?
Here are five labor market indicators:
1. Claims for unemployment compensation. The number of people filing for unemployment benefits has been very low, but it has picked up since last fall and is now very similar to pre-pandemic levels.
Verdict: A promising sign that excessive labor market tightness is beginning to ease.
2. Job openings. The number of open jobs relative to the available labor pool has been trending downward, but it remains well above pre-pandemic levels. It is encouraging that some of the sectors with the largest number of open jobs are also ones that are seeing the fastest retreat, as business activity tapers off. These include the leisure and hospitality industry, which passed through a strong post-pandemic recovery period, and the struggling tech sector (included in Professional and Business Services). Some other major sectors that have experienced weaker activity recently (for example construction) now have job openings rates close to 2019 levels.
Verdict: An encouraging trend, but businesses are still having trouble finding workers.
3. Wages. Growth in average hourly earnings has declined from its peak in early 2022, but remains higher than normal. Data on new wage offers from Indeed.com's Indeed Wage Tracker show a continuing steady decline in advertised wage growth from more than 9% in early 2022 to just over 5% in May. Both measures tend to average about 3% over the long run.
Verdict: Wage pressures are easing surely but slowly.
4. Change in payroll employment. The net number of new payroll jobs created by US businesses has been on a downward trend for the past two years but rose in April and May. Even if recent increases do not signal a return to robust job growth, the rate of deceleration has slowed compared with its behavior between mid-2021 and mid-2022.
Verdict: Firms continue to hire more rapidly than expected, and the most recent data defies a generally downward trend.
5. Unemployment. The unemployment rate has been running at or near half-century lows. For a while, this was explained in part by a slow return of workers to the labor force in the pandemic's aftermath, but the labor force is now above its 2019 level. The unemployment rate did rise in May, from 3.4% to 3.7%, but that is not substantially higher than the 3.6% recorded in February.
Verdict: The proportion of the labor force looking for work remains unsustainably low.
Verdict for the labor market overall?
The labor market remains tight and therefore likely in the short run to continue to drive inflation that exceeds desirable long-run performance. But by many measures, progress toward easing labor market pressures is already evident and clearly ongoing. The economy is on track to slowly converge to satisfactory long-run labor market conditions.
What might all of this mean for this week's FOMC meeting?
Fed Chairman Powell has repeatedly put emphasis on the tight labor market as a key consideration in setting interest rate policy. For example, from his prepared remarks for his press conference following the May FOMC meeting and responses to reporters' questions:
"We remain committed to bringing inflation back down to our 2 percent goal and to keep longer-term inflation expectations well anchored. Reducing inflation is likely to require a period of below-trend growth and some softening of labor market conditions."
He acknowledged that some progress in normalizing labor market conditions has been made:
"...[T]here are some signs that supply and demand in the labor market are coming back into better balance. The labor force participation rate has moved up in recent months.... Nominal wage growth has...shown some signs of easing, and job vacancies have declined so far this year."
But still, he contends that labor demand remains "extraordinarily tight":
"But overall, labor demand still substantially exceeds the supply of available workers."
So the question is whether the FOMC has now seen enough evidence of ongoing labor market slowing to consider this problem well on the way to being solved without the need for further rate hikes.
To be sure, labor market conditions are only one of the many factors that the Fed will consider when it makes its rate decision Wednesday. Keeping rates fixed for now—the so-called "pause"—will also depend on whether they see sufficient signs that aggregate demand and economic activity are weakening (Powell noted several places where they are beginning to see such slowing), remaining tightness in lending conditions in the wake of the Silicon Valley Bank collapse, inflationary expectations, and of course the recent path of inflation itself.
In this regard, keep an eye out tomorrow for the June Consumer Price Index (CPI) release. While the Fed puts more emphasis on the alternative PCE measure, which continues to show worrisome inflation momentum, a big movement in one of the key CPI components, like costs of shelter or other services, could have an impact on their decision.
In addition to these factors, the Fed recognizes that monetary policy acts with a lag, so a pause may be appropriate simply to give the central bank time to see whether the substantial interest rate hikes of the past year will yet feed through to more significant economic slowing and a return to its long-run 2% inflation goal.
The overall labor market picture is consistent with a Fed pause in rate hikes at this week's FOMC meeting.