Fed Officials Are Concerned About Hot U.S. Labor MarketBy
Minutes of last FOMC meeting may reveal concern at overheating
U.S. jobless rate of 4.1% balanced by inflation under target
Federal Reserve officials have penciled in a gradual path for raising interest rates, but minutes of their last meeting may show increasing concern that the U.S. labor market is overheating.
Scheduled for release at 2 p.m. in Washington on Wednesday, the minutes of the Federal Open Market Committee’s Oct. 31-Nov. 1 closed-door debate could harden investor expectations for a further tightening of monetary policy even though inflation remains below its 2 percent target.
Policy makers already upgraded their view of the economy, saying economic growth was progressing at a “solid rate” while joblessness “declined further.” Unemployment fell to 4.1 percent in October, a 16-year low, and the tone of the talks could confirm trades that the Fed will raise rates in December and suggest support for several more moves in 2018.
“The decline in the unemployment rate seems to be weighing heavily in their thought process,” said Stephen Stanley, chief economist at Amherst Pierpont Securities in New York. “The Fed views policy from a risk management perspective and the risk is going too slowly.”
The FOMC meeting concluded the day before President Donald Trump announced he had picked Governor Jerome Powell to replace Janet Yellen when her term as chair ends Feb. 3. Officials were not expected to have broached the subject during their policy discussions.
Investors see a higher than 90 percent chance of a rate increase next month, according to pricing in federal funds futures contracts, and the odds of a hike in March have climbed above 50 percent. The minutes could help to cement that expectation.
“I do think we could get a sense of their near-term expectations for a rate hike,” said JPMorgan Chase & Co.’s Chief U.S. Economist Michael Feroli in New York. While the wording might not be explicit, it could say “perhaps that a hike would be appropriate soon,” he said.
Some traders see the dramatic flattening of the Treasury yield curve, which represents the gap between short- and longer-term market rates, as possibly spooking the Fed from plowing ahead with the current pace of policy rate hikes they now envision. That’s because curve flattening is historically a signal that investors see growth and inflation slowing in the years ahead.
The difference between two- and 10-year Treasury yields collapsed Tuesday to 57 basis points, its narrowest since 2007 when the global financial crisis was unfolding.
The FOMC’s forecasts in September showed the median expectation for one additional hike this year and three in 2018. The committee’s views on the outlook for unemployment and inflation might suggest they are still expecting several hikes next year.
The FOMC’s participants have generally concluded that the economy is at or very near full employment.
Dallas Fed President Robert Kaplan said Friday that “we are likely to overshoot maximum sustainable employment” and that needs to be taken into account in forming monetary policy. Philadelphia Fed chief Patrick Harker said last week that “with the labor market this tight, inflation is likely to reassert itself at some point.” Both are policy voters this year.
On the other hand, James Bullard of St. Louis has argued that the labor market has little impact on inflation and further hikes could lower inflation expectations. The Fed’s preferred measure of prices rose 1.6 percent in the 12 months through September and has been below target for most of the past five years.
How widespread the doubts are on inflation will be telling.
“While growth is solid for now, the path of rate hikes next year is not set in stone,” said Chris Rupkey, chief financial economist with MUFG Union Bank in New York. “We want to take a headcount over those wavering over inflation. Is it ‘many’ or ‘several’ or ‘some’ or ‘few’?”
Concern over asset prices could suggest another reason to continue rate hikes. In the June meeting, a few FOMC participants worried that equity prices were high and some participants were concerned investors were taking on risks leading to “elevated asset prices more broadly.”
“If inflation fails to move up, then either they will have to slow the pace of hikes, or change the message to relate the need for tightening to financial stability as well as inflation,” said Jonathan Wright, an economics professor at Johns Hopkins University in Baltimore.
— With assistance by Liz McCormick