Strong Jobs Report Doesn’t Resolve Fed Debate on Next Rate Rise

Fed officials have kept their options open for their Jan. 31-Feb. 1 meeting by declining so far to spell out what might lead them to approve another half-point rate rise or to step down to a more traditional 0.25-point increase. “I am very open to both,” said Atlanta Fed President Raphael Bostic during a panel discussion Friday at an economics conference in New Orleans.

The employment report which showed that strong job growth continued to tighten the labor market in December, is important because many Fed officials have shifted their attention from inflation readings to the labor market. They are concerned that inflation, while expected to decline this year, could settle at uncomfortably elevated levels, particularly if it leads workers to bid up wages.

The report offered little evidence that the Fed’s rapid rate rises last year have significantly slowed hiring. Employers added 223,000 jobs in December and the unemployment rate dropped to 3.5% from 3.6% in November, returning to a 50-year low.

But revisions to figures on wage growth showed recent gains weren’t as brisk as previously thought and instead indicated they continued slowing through the end of the year. Hourly wages rose 0.3% in December, bringing the 12-month increase to 4.6%, the lowest such reading in more than a year. 

Last month, the Labor Department reported wage growth had accelerated in November, rising 5.1% from a year earlier. But on Friday, revisions to that data brought the annual increase to 4.8% in November. 

Moreover, the average workweek declined for the second straight month in December, a sign of moderating demand for workers. Also, a separate business survey released Friday showed a large decline in new orders for service-sector firms.

After the release of Friday’s reports, investors saw a roughly 75% probability of a 0.25-point rate increase at the Fed’s coming meeting, and a 25% probability of a larger half-point bump, according to interest-rate futures market prices compiled by CME Group.

Chicago Fed President

Charles Evans,

who retires next week, said in an interview Thursday that last month he projected the fed-funds rate rising this year to between 5% and 5.25%.

He said it was possible recent economic data would support raising the rate by 0.25 percentage point, or 25 basis points, at the next meeting.

“The [Fed] is in a good spot having stepped down to a 50-basis-point increase in December,” said Mr. Evans. “If they step it down again to 25 basis points that allows a little more time—as they continue to increase the funds rate to the same point that I was expecting—to let the data evolve.”

Slowing rate rises to 0.25-point increments wouldn’t mean the Fed is preparing to stop them, he added. “You can start doing 25s and you can still string them out,” said Mr. Evans. “So just going to 25 doesn’t mean that a pause is imminent.”

Some analysts said they expected the jobs report to support such a policy shift. “While job growth remains vigorous, the details of today’s report give us more confidence that employment gains will slow notably in coming months,” said Michael Feroli, chief U.S. economist at JPMorgan Chase, in a note to clients Friday. “The hints of moderation in labor demand are probably enough to let the Fed dial down to a [quarter-percentage-point] rate hike pace at the next meeting, though it’s far too early to contemplate a pause.”

Economists at Bank of America, meanwhile, said the report suggested the Fed wasn’t making enough progress to ease labor-market imbalances and said a half-point rate rise was more likely next month. “There is good news in this report to be sure, but not enough for policy makers to downshift to a [quarter-point] hike,” wrote Michael Gapen, chief economist at Bank of America.

Fed officials have broadly agreed that unemployment is likely to rise this year and next year as they combat inflation that is coming off 40-year highs. Projections from 19 policy makers submitted at their meeting last month show most expect the jobless rate to rise to between 4.4% and 4.7% this year. Increases of that magnitude have nearly always coincided with a recession.

“There will be some softening in labor market conditions,” said Fed Chair

Jerome Powell

at a news conference last month. “And I wish there were a completely painless way to restore price stability. There isn’t. And this is the best we can do.”

Job openings held nearly steady at historically high levels in November, adding to evidence the labor market remained strong heading into 2023, according to a separate Labor Department report released Wednesday. The figures showed layoffs stayed low and a larger share of workers quit their jobs in November than a month earlier, a sign Americans were still confident in their employment prospects.

The data point to a solid overall job market even though some large technology companies are announcing layoffs.

Annual inflation slowed to 7.1% in November from its recent peak of 9.1% in June, as measured by the Labor Department’s consumer-price index. The department is set to report December figures next week.

Evidence has mounted that prices of goods could decline further as supply-chain bottlenecks abate and that rents and other housing costs increases are likely to slow later this year. But Fed officials are concerned that the labor market’s strength could sustain wage growth that keeps inflation, as measured by their preferred Commerce Department gauge, above their 2% target.

Mr. Powell has recently shifted the focus away from broad inflation measures toward a narrow subset of labor-intensive services by excluding prices for food, energy, shelter and goods.

Officials are trying to balance the risk of raising rates too much and creating unnecessarily higher unemployment with the risk of not doing enough to slow down spending and investment, which could allow higher inflation to become entrenched.

Mr. Powell said at the news conference it was “broadly right” that the Fed’s best way to manage the risk of over-tightening would be to slow rate increases to smaller, more traditional 0.25-point increments as soon as the central bank’s next meeting.

“It makes a lot of sense, it seems to me—particularly if you consider how far we’ve come,” Mr. Powell said. But he said twice that the Fed hadn’t decided what to do at its coming meetings and that its actions would depend on the state of the economy and borrowing conditions.

Most Fed policy makers last month anticipated that they would need to raise the fed-funds rate to rise at least to above 5% this year. “I think it would behoove the committee to get into that zone as soon as we can without ignoring the data,” St. Louis Fed President James Bullard told reporters on Thursday.

He didn’t directly say which size rate increase he would prefer at the Fed’s next meeting and suggested that economic data released over the next two weeks would shape the decision.

More broadly, Mr. Bullard said recent economic data buoys the Fed’s chances of slowing inflation without a serious economic downturn—achieving a so-called soft landing.

“The probability of a soft landing has increased compared to where it was in the fall of 2022, where it was looking more questionable,” Mr. Bullard said. “The labor market has not weakened the way many have predicted,” suggesting the economy is more resilient and providing Fed officials “a little more time to get inflation down to the 2% level,” he said.

—Austen Hufford contributed to this article.

Write to Nick Timiraos at [email protected]