Strong job gains could sap Fed confidence on inflation

By Ann Saphir and Howard Schneider

(Reuters) -Federal Reserve policymakers seeking greater confidence that inflation is on track to their 2% goal may have found it sapped instead on Friday when data showed U.S. job growth surged last month at well above the pre-pandemic pace, and wage growth accelerated.

The numbers – 353,000 new jobs added across a broad range of sectors and hourly earnings up 4.5% from a year earlier – do not put U.S. central bank officials off course for interest rate cuts later this year.

But ongoing labor market strength could make the road to rate cuts a longer one. Revisions published Friday to last year’s data show the U.S. economy added 3.1 million jobs last year, more than the 2.7 million earlier estimated, despite the Fed’s aggressive rate hikes.

This week, Fed Chair Jerome Powell said the job market need not necessarily weaken to get progress on inflation, which fell sharply from 5.5% at the start of last year, to 2.6% by the end.

But continued outsized job gains could add to the Fed’s caution about easing policy too soon.

“The Fed would be very wary of cutting into a reaccelerating economy,” wrote Evercore ISI economists. “Strong growth and employment makes the Fed want to accumulate more evidence subdued inflation can continue.”

The central bank on Wednesday kept its benchmark overnight interest rate in the 5.25%-5.50% range, where it has been since July. Powell said that would likely mark the peak, and that rate cuts would only come once policymakers have “greater confidence that inflation is moving sustainably down to 2%.”

Data delivering a sufficient degree of confidence was unlikely to be in hand before the Fed’s meeting next month, he said.

The January jobs data, which also showed the unemployment rate unchanged at 3.7%, may do little to assure policymakers that labor market rebalancing is helping to solidify inflation’s downward trajectory.

“Hotter-than-expected payroll and wage growth will likely encourage the Fed to hold pat as they feel little pressure to begin cutting rates,” Daniel Zhao, a lead economist at Glassdoor, said after the release of the data.

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After the report, some Wall Street analysts that had held on to their forecasts for a March rate cut abandoned those in favor of May or June.

Traders of futures contracts that settle to the Fed’s policy rate chopped the price-implied probability of a first quarter-of-a-percentage-point rate cut at the March 20-21 meeting down to about 20%.

They still see a rate cut by the Fed’s April 30-May 1 as very likely, giving it about a 70% probability.

Traders also pared expectations for the total depth of rate cuts in 2024, and now see the Fed more likely to end the year with the policy rate at 4.00%-4.25%. They had previously seen that rate ending 2024 at below 4%.

REVISIONS, SKEPTICISM

Some analysts downplayed the January jobs report, noting the post-pandemic labor market is atypical and saying strength of job gains may be overstated due to statistical adjustments informed by seasonally typical patterns of hiring and firing.

Other recent data does encourage faith in inflation’s further decline this year along with worries about potential cracks in the labor market, including a string of strong productivity data and reports of rising layoffs.

Analysts and Fed policy makers will watch next Friday’s annual revision to the estimates for consumer inflation, which fell by almost half to 3.3% by December.

Last year’s update to the prior year’s consumer price index data erased what had looked like good progress on inflation in 2022, and Fed Governor Christopher Waller says he will be watching this year’s revisions closely.

CBS’ “60 minutes” program will air an interview with Powell on Sunday. It was not clear if the Fed Chair, who gets early access to critical economic data, had the report in hand at the time of the interview.

Several Fed policymakers, including the hawkish president of the Cleveland Fed, Loretta Mester, and the dovish president of the Philadlphia Fed, Patrick Harker, are on tap next week to give their own evolving views on the likely timing of rate cuts.

(Reporting by Ann Saphir; Editing by Hugh Lawson, Paul Simao and David Gregorio)