MNI INTERVIEW: Fed Hikes Just Starting To Weigh On Jobs-KC Fed

The Federal Reserve's historic tightening of monetary policy is only beginning to negatively affect the labor market, although conditions are not quite as tight as they appear, Kansas City Fed economists Jose Mustre-del-Rio and Emily Pollard, whose work studies this lagged impact, told MNI.

During the last 20 years, the KC Fed's Labor Market Conditions Indicators' measure of labor market momentum has generally turned negative within a year of the start of monetary policy tightening cycles, suggesting Fed policy is beginning transmitting to labor markets. Yet so far in the current cycle, the LMCI has not shown much of a decline.

The LMCI momentum measure dropped below its longer-run average in November for the first time since June 2020 and turned slightly negative at -0.17, before turning upward again to 0.07 in January on the back of strong jobs growth, initial claims and the labor force participation rate.

"All of those numbers are very, very close to zero," said Pollard, pointing out the measure fell to -10 during the depths of the pandemic. After other Fed tightening cycles LMCI momentum fell to between -2 and -2.6.

The Fed has raised interest rates by 450 basis points in the last year to a range of 4.5% to 4.75% and is expected to deliver additional increases for at least another two policy meetings.

"By most measures it still appears that the labor market has remained quite resilient to the changes in monetary policy at least with respect to a historical context," said Mustre-del-Rio. "To confidently say that the labor market is softening as a result of policy changes we would have to see more systematic movement in momentum below zero much like we saw in the previous tightening cycles."

The economy generated over half a million jobs last month while the jobless rate fell to a new 50-year low of 3.4%. (See: MNI INTERVIEW: Employment Could Be Less Sensitive To Fed Hikes)

NOT QUITE SO TIGHT

But adjusting the unemployment rate to incorporate information from the LMCI measure suggests the labor market is a bit looser than the jobless rate alone implies and is consistent with a 3.8% rate, the KC Fed economists said. Last March, the LMCI-implied unemployment rate stood at 3.1%.

"While the LMCI-implied unemployment rate had been systematically below the official rate for the past couple of years, it appears it moved above the official rate sometime late last year," said Mustre-del-Rio. "This is perhaps to be expected since that is right around when momentum turned negative, and similarly, the activity indicator started softening."

Analysis by Mustre-del-Rio and Pollard also suggests wage growth tends to slow and unemployment tends to rise a year or two after LMCI momentum turns consistently negative. If the recent negative readings in LMCI momentum are sustained, other labor market variables, such as wage growth, are likely to begin to soften, reducing price pressures in the services sector and likely helping to reduce overall inflation, they said.

Fed officials in past have cited the LMCI as a leading indicator of the labor market. The FOMC's December projections saw unemployment rising to 4.6% by the end of the year, but some have since lowered their forecast.