MNI INTERVIEW: Weak Labor Supply May Drive Fed Hikes-Adviser

Americans may have developed more European preferences for leisure over work during the Covid pandemic, squeezing labor supply amid elevated wage inflation that will keep the Fed hiking interest rates, Cleveland Fed and ECB academic consultant Michael Weber told MNI.

Weaker labor force participation is due to more than just the common diagnosis of an acceleration of early retirements, Weber said Monday. Americans now appear less eager to work long hours or full-time positions, the associate professor at University of Chicago's Booth business school said.

"Recently there are some people who are referring to a ‘Europe-ification’ of the U.S. labor market, and that people partially changed their preferences trading off leisure and labor," said Weber, who is also a visiting researcher at the Bureau of Labor Statistics. Americans on average worked 1,777 hours a year in 2019 compared with 1,382 in Germany and 1,518 hours in France according to the latest OECD figures.

The search for different work arrangements "I think permanently changed the structure of the U.S. labor market," Weber said. "Part of the reduced participation is due to most likely permanently changed preferences of a chunk of the U.S. labor force."

The labor force participation rate of 62.4% in January is almost a full percentage point less than where it was before Covid dragged the economy into a recession, and the number of multiple job holders has fallen 20%. Participation has remained lower despite bigger wage gains and about the lowest unemployment rate in half a century.

WAGES CREATE FED HEADACHE

Pay gains remain elevated even with the Atlanta Fed's wage tracker showing a recent moderation, Weber said. Gains of more than 6% in overall wages and 7% for job switchers “aren’t consistent with reaching 2% inflation in the near term,” he said, adding he expects wages to continue to grow quickly perhaps into early next year.

“Strong nominal wage growth, this will certainly create quite a bit of headache for the Federal Reserve, and going forward most likely will result in a couple of more policy rate increases," Weber said. Chair Jerome Powell said after hiking the fed funds rate to 4.5%-4.75% that the December dot plot showing a 5.1% rate by year-end was reasonable and the FOMC could go further if needed.

The Fed may ultimately hike beyond 6% given the economy's recent strength, former policymakers and staff have told MNI. (See: MNI: Fed’s Peak Rate Looking Perkier As Jobs Boom-Ex-Officials)

In contrast, some investors are betting on a rate cut late this year. While it's hard to say who's right, Weber said "too optimistic markets regarding rate cuts might in fact exactly make sure that the rate cut won’t happen.”

Recent months have brought reason for optimism about achieving a soft landing, with headline inflation slowing and monthly CPI readings more helpful, Weber said.

MORE CLARITY AT ECB

While the delayed drag of last year's rate hikes is still to inflict some pain, "there are definitely many good signs and hope inflation is coming down,” this year, he said.

“In general, soft landing has been rare, it’s really difficult. I’ve become more optimistic over the end of last year, early this year that a soft landing might be feasible."

Still, risks persist, from the Ukraine war to China's re-opening, Weber cautioned. One external factor that has become clearer is the European Central Bank’s determination to curb inflation.

“The ECB has actually a longer way to go in terms in a tightening cycle, and over the last couple of meetings that have been consistent in stating that they actually will need to tighten more,” Weber said. “Over the last few months the ECB has been pretty clear.”