Red Hot Jobs Report, But What About the Debt Ceiling?
Everyone was blown away by the huge 517,000 January increase in payrolls and upward revisions to earlier months, the decline in the unemployment rate, and the surge in the workweek. These numbers imply that it would be premature for the Fed to pause rate hikes and irresponsible for them to contemplate a pivot to reduce rates.
The large gains in hiring indicate that the economic expansion remains on a solid footing and the risks of recession lie a bit further in the future. We have been pushing our recession forecast out for some months now and must do so again. However, the risk of recession has also increased. The economy has even more momentum than we observed prior to this report, so it may take somewhat higher interest rates to restrain growth and rein in inflation, making a “soft landing” harder to achieve. It is safe to speculate that Fed officials were not happy with such strong job growth.
What is most remarkable about the pace of hiring is that it is taking place even as the pool of unemployed has shrunk considerably. Unemployment totals a mere 5.7 million, yet more than 0.5 million were hired within a single month. Since it is logistically impossible to get the unemployed down to zero, the pace of hiring must slow quite soon and quite dramatically. Nonetheless, while firms may be unable to find workers, the rise in job openings back above 11 million suggests that they will continue to try to hire. Such an imbalance between labor demand and labor supply is precisely the dislocation that produced surges in inflation. We (and the Fed) will be very focused on the behavior of wage inflation.
Expectations for inflation continue to moderate, although that decline is overstated. Just as shortages and supply chain disruptions artificially boosted measured inflation, increased availability of goods will artificially depress measured inflation below its underlying trend for a period of time. For example, new car prices surged from MSRP minus $5,000 to MSRP plus $5,000 due to shortages. They are now reverting back to discounts again. But MSRP will rise, reflecting higher costs. It is that underlying trend that really matters and it is the tightness of the labor market that creates upward pressure on that underlying trend. So, the “news” on inflation will look better than it should for the next several months. The markets may get unduly excited by this apparent improvement, but the Fed knows better, which is why it keeps warning investors that interest rates must stay higher for longer. We expect another two rate hikes of 25 basis points at the next two Fed meetings.
Of course, the market’s Panglossian view took a major hit from the strength in the payroll report and the market’s recalibration might take a little time. Bonds fell sharply on Friday, as was entirely appropriate, yet the decline in stock prices was milder than could have occurred. A full adjustment to the data has likely not yet occurred. But there are a few saving graces: economic growth will hold up better and so should corporate profits. And having fallen so much already, stocks are now valued more reasonably than at the beginning of last year.
The Debt Ceiling Issue
We’ve been asked repeatedly about the outlook for resolving the debt ceiling issue. It isn’t actually an economics question. There is absolutely no economic justification for having a debt ceiling limit. Congress has already approved the spending. By analogy, it isn’t a question of whether to spend the money, but whether to pay the credit card bill that arrived after the purchase was put on the card.
The debt ceiling is a political issue, since members of Congress use it as a second opportunity to push for their pet programs or spending priorities that weren’t approved the first time around. And because it is a political issue, it can only be resolved by political compromise. As everyone knows, Washington D.C. isn’t exactly renowned for its willingness to compromise these days. So, this show in Washington is an embarrassing game of chicken played out in public for all to see. The safest bet is that the deal to settle the issue will be pushed to the very last minute, unless there’s an interim compromise to push out the deadline ever so slightly. A deal will certainly be struck, and hopefully, before it is disruptive to the markets.
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