Latest job report sets stage for 50bp Fed rate hike in May
The highlight of the US employment report for March was the sharp drop in the unemployment rate to only 3.6%, the lowest level since the pre-pandemic rate of 3.5% posted in February 2020. In itself, such a rapidly declining unemployment rate shows the entrenched, robust momentum of the US economy, and a recession still appears at bay. A red flag would be a stagnating unemployment rate, but so far the unemployment rate seems to be barrelling down almost unstoppable. Wage growth (average hourly earnings) remains firm at 5.6% y-o-y, although looking at the more granular level over the past two months, there seems to be some cooling-off potentially happening very recently.
The Federal Reserve could still continue to worry about the potential emergence of a 1970s-style wage price spiral. After a first hike of +25bps in March, we continue to think the Fed’s next rate move will be a +50bp hike at its next scheduled meeting in May due to its ongoing concerns abou inflation becoming more entrenched. We also think the Fed will announce the shrinkage of its balance sheet in May.
But since we do not expect such a wage-price spiral to materialise, we think the Fed could return to more serene pace of hikes after May (and, after summer, potentially pause rate hikes altogether). Long-term interest rates have already backed up a lot and could start to affect the economy, with a lag, post summer.
Impressive labour-force momentum means that recession still seems some way off, although things could change rapidly. Business-cycle and interest-rate sensitive sectors such as construction and real estate could start to suffer if the Fed pushes up rates too rapidly. While not a major red flag, there are already signs of unease in some homebuilder-sentiment surveys as mortgage rates soar. But while housing transactions have also softened of late, it may take several months before a more hawkish Fed feeds into the real economy.
The next crucial indicators the Fed will watch are the March consumer price index (to be released on 12 April, with consensus expectations for a 1.2% rise m-o-m, up from 0.8% in February), and the Q1 employment cost index on 29 April.