The robust labor market in the U.S. could be muddying the waters for Fed officials, obfuscating their vision for a soft economic landing and likely ensuring that interest rates will remain higher for longer.
The U.S. added a surprising 517,000 jobs in the first month of 2023, more than three times higher than expected, according to January’s nonfarm jobs report.
The U.S. labor market is “certainly strong, stronger than anyone I know expected,” Federal Reserve Chairman Jerome Powell said during a discussion with David Rubenstein, chairman of the Economic Club of Washington, D.C., on Tuesday. “It kind of shows you why we think this will be a process that takes a significant period of time.”
Since the Federal Reserve began its restrictive policy stance in March 2021, Fed officials have approved eight consecutive rate hikes and increased the Effective Federal Funds Rate (EFFR) to a range of 4.50%- 4.75%.
The Federal Open Market Committee’s summary of economic projections for the EFFR shows a peak rate of 5.1% by the end of 2023, according to the median forecast among Fed officials.
In total, the U.S. central bank projects two more quarter-percentage-point increases and the EFFR to peak between 5% and 5.25%, though Fed officials have reiterated the importance of being patient and following data as it comes in.
“The reality is we’re going to react to the data,” Powell said during the discussion.
“So, if we continue to get, for example, strong labor market reports or higher inflation reports, it may well be the case that we have to do more and raise rates more than is priced in.”
Inflation hit a four-decade high of 9.1% in June of 2022. Since then, inflation has fallen by 2.6%, with December’s 6.5% reading marking the sixth consecutive decrease. Still, December’s 6.5% reading remains well above the Fed’s 2% target goal.
Powell suggested during the discussion that returning inflation to 2% and keeping it there will be more challenging than expected, adding that inflation is not likely to go away quickly and painlessly.
“The base case for me is that we’ll have to do more rate increases, and then we’ll have to look around and see whether we’ve done enough,” he said.
Unlike last year, Fed officials “appear content conveying that they will respond to the data and letting the market take that as fair warning,” said Michael Feroli, chief U.S. economist at JPMorgan Chase, according to reporting by The Wall Street Journal.
“This year, the market shouldn’t expect the same degree of hand-holding,” Feroli said.
