As unemployment concerns loom, the Federal Reserve weighs the option of reducing interest rates, despite inflation worries. Powell’s unwavering focus on curbing a potential downturn in employment underscores the Fed’s dedication to safeguarding the labor market. This proactive stance toward preserving jobs may serve as a crucial pillar for the economy and could potentially buoy risk assets.
Amidst the backdrop of surging inflation in 2022, the Federal Reserve swiftly responded by increasing interest rates to curb potential wage-hike spirals. However, with unemployment rates showing signs of an uptick, the central bank now signals a willingness to adjust rates downward to prevent a cascade of job losses – even if it means tolerating somewhat higher inflation in the short term.
Federal Reserve Chair Jerome Powell made a noteworthy departure from previous stances during Wednesday’s press conference, explicitly stating that an unforeseen rise in unemployment could prompt rate cuts. This sentiment was reiterated several times in response to questions from reporters, marking a notable shift in the Fed’s strategy amidst the current economic landscape.
Following the conclusion of the two-day policy meeting, Federal Reserve Chair Jerome Powell reiterated the central bank’s stance of awaiting confirmation of victory in the battle against inflation before considering rate cuts. However, Powell acknowledged that unforeseen weaknesses in the labor market could necessitate a policy adjustment. Despite Powell’s reassurance regarding the current state of the job market, some economists remain skeptical. They highlight significant upticks in unemployment rates across several states, ongoing declines in temporary staffing, and reductions in working hours as potential warning signs for the labor market’s health.
Despite current confidence in the labor market, Federal Reserve Chair Jerome Powell and his colleagues remain cognizant of its potential for swift deterioration. Historically, once unemployment begins to rise, it tends to escalate significantly as companies initiate layoffs in succession.
In a bid to preemptively address this risk, Powell has left the door open for potential rate adjustments if the labor market experiences undue weakness. This strategy appears to aim at disrupting the cascade of layoffs, offering a measure of stability amidst uncertainty.
According to Wendy Edelberg, former Fed economist and director of the Brookings Institution’s Hamilton Project, Federal Reserve Chair Jerome Powell’s approach aims to prevent the unemployment rate from gaining momentum. Edelberg suggests that Powell’s ability to maintain the possibility of easier credit is facilitated by inflation being “within spitting distance” of the Fed’s 2% target. She asserts that the Fed can tolerate slightly higher inflation for a few years without needing to exert significant pressure on the labor market to control price rises.
Powell himself emphasized the Fed’s commitment to gradually bringing inflation down to 2% over time, providing assurance that the process will be gradual.
This approach holds political significance for President Joe Biden as he navigates towards a potential second term, particularly given the public’s current skepticism about his economic management. A substantial increase in unemployment could further tarnish Biden’s economic reputation ahead of the November elections.
Moreover, investors stand to benefit from this strategy. With inflation levels considerably lower than they were two years ago, the Fed now has room to offer more support to the economy, which indirectly benefits financial markets.
Sophia Drossos, economist and strategist at global asset manager Point72, noted that central banks, particularly in the US, are taking measures to support the growth aspect of their mandate, which is conducive to risk assets. This sentiment underlines the supportive environment for investors amidst the Fed’s strategy.
Federal Reserve Anticipates Job Market Slowdown, Forecasts Slight Rise in Unemployment
According to the latest economic projections from Federal Reserve officials, a modest uptick in unemployment is expected this year, albeit not significantly. Policymakers foresee the jobless rate climbing to an average of 4% in the last quarter of 2024, up from its two-year high of 3.9% recorded in February, based on their median forecast.
Amidst indications of companies scaling back on hiring, the Fed remains wary of the potential for a rapid increase in unemployment due to a wave of layoffs. However, Fed Chair Jerome Powell has expressed optimism, citing the notably low level of jobless claims as a reassuring factor.
Despite Powell’s optimism, some economists observe signs of a slowdown in the job market. Analysis by UBS Securities Chief US Economist Jonathan Pingle reveals that twenty states, including notable ones such as New York, California, Arizona, and Wisconsin, have experienced significant increases in unemployment, meeting the criteria of the so-called Sahm recession rule.
Originally conceived by former Fed economist Claudia Sahm and now a Bloomberg Opinion columnist, the Sahm rule serves as an early warning system for recessions, signaling their onset when the three-month moving average of the US unemployment rate rises by at least half a percentage point compared to its low over the previous 12 months. While this threshold has yet to be met nationwide, some analysts, such as Drew Matus from MetLife Investment Management, argue that certain categories of workers, such as those with a high school diploma or nearing retirement, have already triggered the rule.
Matus, who also predicts a recession in 2024, highlights increasing unemployment rates as a concerning trend, suggesting potential challenges ahead for the labor market.
Data compiled by Automatic Data Processing Inc. (ADP) suggests a potential indication of a softer job market: many Americans are working fewer hours compared to pre-pandemic levels. According to ADP Chief Economist Nela Richardson, hourly workers collectively are putting in less time on the job, raising questions about whether this reduction is voluntary or a result of companies trimming employee hours. Regardless of the underlying reasons, the shortened workweek implies that for numerous workers, their weekly pay fails to keep pace with inflation.
Despite these concerns, San Francisco Fed President Mary Daly expressed optimism in Washington last month, stating that the likelihood of a severe downturn in the job market appears remote. However, Daly cautioned that given historical precedent, where labor market shifts can occur rapidly, it’s essential to remain vigilant about the risk of such a downturn.