Note to Fed: Time to Pause

Nobody at the Federal Reserve has asked for my opinion, but here it is: Once again, it is time to pause on rate hikes. I know that central bankers are terrified that inflation will rear its ugly head again, and admittedly, the July CPI report is likely to show an increase in annual inflation to 3.3 percent from June’s 3 percent, when the government releases the report on August 10th. But it appears that despite the Fed’s late start in the campaign to fight inflation, the economy has been able to absorb the highest interest rates in 22 years, without careening into a recessionary ditch.

The resilient labor market is a prime example of the fact that the economy is cooling, but not freezing over. In July, there was a 187,000 gain in payrolls and the previous two months were revised lower by a total of 49,000 jobs. That puts average monthly job creation for 2023 at 258,000, down from nearly 400,000 per month in 2022 and more than a half a million jobs per month in 2021. Importantly, the June and July results were the slowest months of job creation in the past two and half years.

Isn’t this deceleration exactly what the Fed wanted? Chair Jerome Powell said as much during the?press conference ?that followed the last policy meeting on July 26: “What we’re looking for is a broad cooling in labor market conditions, and that’s what we’re seeing.” Cool enough yet, Chair Powell? Maybe not. Some inflation hawks will point to still-too-high average hourly earnings, which showed an annual increase of 4.4 percent in July, greater than the Fed’s desired 3.5 percent or so. (In the presser, Powell said the central bank does not have a target for wage inflation, but they are pleased that “wages have actually been gradually moving down.”)

Capital Economics’ Paul Ashworth notes that while July’s wage growth might seem like a problem for the Fed, “with productivity growth accelerating, however, it may not be.” When workers are more productive, then labor cost growth moderates, and according to Ashworth, “the recent slowdown in unit labor cost leaves it very close to its pre-pandemic average and it is consistent with a big drop back in core services inflation, which would be consistent with overall core inflation dropping to 2 percent on a sustained basis.”

The data dependent Fed will have one more employment report and two more months of inflation data before the next policy meeting in September. Bill Adams, Chief Economist for Comerica Bank, believes “With the labor market very strong, wages rising solidly, and core inflation well above the Fed’s target, odds are better than 50-50 that the Fed makes another quarter percentage point rate hike in the second half of 2023, most likely at the Fed’s November 1 decision.”

So much for my advice!