The Fed has laid out what it hopes from inflation data in order to be able to end its tightening cycle and later ease monetary conditions again.

There used to be a time when the US non-farm payroll data were the mainstay of the monthly calendar. But not anymore; that position has been assumed by the CPI report. This is unlikely to change anytime soon but labour market data should not be discounted as it may ultimately provide the key that unlocks easier Fed policy.

The Fed has laid out what it hopes from inflation data in order to be able to end its tightening cycle and later ease monetary conditions again. It clearly wants inflation to return to the target. But what about the other half of its policy mandate; the unemployment rate?

Here it seems that it wants – or at least expects – the unemployment rate to rise above the Fed’s own view of full employment for a period of time. According to the last set of forecasts from FOMC members, the median forecast is that the unemployment rate will rise from today’s 3.7% rate to 4.4% in Q4 2023 and it still expects the unemployment rate to be above this level in Q4 2024 before declining slightly in 2025. These forecasts put the unemployment rate above the 4% “longer-term” rate assumed by the Fed, and assumed by the market to be the Fed’s characterisation of full employment.

In the past, economic slowdowns in the US, and recessions in particular, have seen unemployment rise much more than the one percentage point that the Fed is assuming this time. But the labour market is incredibly tight with close to two jobs for every person that’s unemployed.

These vacancies will undoubtedly come down as firms see demand falling, but there are also bound to be many firms whose labour demands are pretty impervious to the ups and downs in the economy. For instance, firms that have tried to fill vacancies since the pandemic may just cling onto any labour they can get even if this means hanging onto it during a recession. Hence it does seem very likely that the rise in the unemployment rate in this downturn/recession will be very mild compared to those that we have seen in the past. The Fed clearly seems prepared to accept this.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said the key question is whether such a tame response in the jobs market will frustrate the Fed’s attempts to rid the economy of high inflation. For if it does, and if unemployment has to be pushed to much higher levels, it could clearly take the sort of monetary tightening that the market has not discounted before now.

On the flip side, of course, if the unemployment rate rises much faster than anticipated the Fed – and the market– may grow hopeful that downward pressure on prices, via more modest wage growth, will come through much more easily and quickly. Hence, we can see that, while the market will still remain transfixed by inflation data, the labour market data is likely to become more important again once prices have peaked.

In many senses we are already seeing some notable downward pressure on goods prices stemming from things such as cheaper commodity prices, lower freight charges and the unblocking of supply chains. But such moderation can only reduce prices so far. If the labour market stays too tight and wages continue to grow at a fast clip, inflation will stay entrenched. After all, for most firms, labour costs dominate other costs, such as materials when it comes to pricing.

“We have to say that we are sceptical that the Fed can get away with such a modest rise in the unemployment rate and still bring inflation back to target. Either inflation will stay stubbornly above target or the Fed will have to push rates up far more than it currently suggests, which brings about a bigger jump in the unemployment rate. At the moment our money is on the former”, said Mr. Steve Barrow.