If one would have asked a year ago if the economy would expand at above a 2.5% clip and produce 4.52 million jobs by the end of the year, all while the Federal Reserve raised its policy rate by 450 basis points, the answer would probably have been no.
But that is just where the economy stands following a robust increase of 223,000 jobs in the December jobs report released by the Labor Department on Friday.
A 3.5% unemployment rate, a 4.6% increase in wages and a still-hot overall labor market do not denote a deceleration in overall economic activity, nor an increase in labor slack that will restore the price stability that the Federal Reserve is trying to achieve.
Those economic conditions set the stage for what will be a contentious three months in economics, finance and policy to kick off a turbulent year.
Policy implications
The increase in December total employment, which brought down the three-month average to 247,000, and the increase in wages will weigh heavily on the Fed’s monetary policy decision at its meeting on Feb. 1.
We think that the Fed should increase the policy rate by another 50 basis points to a range between 4.75% and 5%.
But given the deceleration in both top-line employment and wage growth—the three-month average annualized pace in average hourly earnings has slowed to 4.3%—the Fed may choose to slow its pace of rate hikes next month, perhaps to 25 basis points from the 50 basis-point increase in December.
The recent jobs and inflation data—the next Consumer Price Index report will be critical—suggests that we are approaching the peak in the policy rate, which in our estimation will be between 5% and 5.25%.
Whether that is correct, or the Fed chooses to push the eventual peak slightly higher, our preferred policy framework of “lift and hold” should set the stage for stabilization in rate and mortgage markets during the second half of the year.
We expect no rate cuts this year, which is a view reflected in the most recent minutes from the Federal Open Market Committee.
Year in review
Even with elevated inflation, the economy generated 4.5 million jobs last year as the unemployment rate declined from 4% to 3.5%.
Demographic changes require that only 65,000 jobs need to be produced per month to meet demand. Despite the 450 basis points of rate hikes and elevated inflation last year, the unemployment rate declined noticeably.
The labor force participation rate to end the year stood at 62.3%, essentially unchanged from the 62.2% at the outset of the year.
To give a sense of just how strong the labor market is, involuntary part-time employment stood at 3.87 million jobs in December, well below its long-term average of 5.4 million.
The percentage of workers who are unemployed, discouraged, marginally attached or working part time for economic reasons fell to an all-time low of 6.5%, which may be the most vivid indication of just how tight the American labor market is.
Beneath the headline
The private sector added 220,000 jobs in December, matching the three-month average of 220,000. Higher-paying goods-producing jobs increased by 40,000, construction jobs advanced by 28,000 and manufacturing employment increased by 8,000.
Private service-providing jobs increased by 180,000, of which 145,000 were in education, health, leisure and hospitality. Trade and transport added 27,000 positions, retail 9,000, finance 5,000 and government 3,000. Employment in the information sector declined by 5,000 jobs, business services dropped by 6,000 and temporary hiring dropped by 35,000.
The median duration of unemployment stands at 8.9 weeks, which implies that many in the technology sector who have lost jobs are quickly finding new ones. That confirms the modest decline in information hiring despite the large number of layoffs across the tech ecosystem.
With the labor force participation rate rising slightly to 62.3%, the employment-to-population ratio increased to 60.1% in December. Despite the statistically significant increase of 717,000 jobs in the household unemployment survey, the overall pool of available labor declined by 630,000 on the month.
That decrease explains most of the decline in the unemployment rate to 3.5% and is illustrative of the demographic changes and tight labor market that will define the remainder of this business cycle and, we expect, the next.
The takeaway
The labor market remains historically tight despite the modest deceleration in hiring and overall wage increases. The downward revision in the pace of hiring and average hourly earnings will create space for the Federal Reserve to consider further slowing rate hikes to what we think will be an appropriate peak of 5% to 5.25%.
