The labor market is red hot, and the Fed isn’t too thrilled about that.

As we head into fall of 2023, the Federal Reserve (Fed) continues to battle inflation. The Fed has made clear that they want to see the unemployment rate increase.  Simply put, the Fed believes that an increase in joblessness will slow down the demand for goods and services, which will cool the economy, and thus bring down inflation. 

Just a quick reminder:  These articles I share here are researched and written by me!  As part of my commitment to ongoing support for my clients and partners, I write these articles to help them understand what’s really happening in the markets, beyond the headlines and soundbites.

This is a common tactic to fight inflation:  When more people are working, they have more spending power, which increases demand, which is the enemy of inflation.  Fewer people working means less demand, which means lower inflation. But the effectiveness of this approach depends upon the makeup of the labor market.  Is today’s labor market like those prior to previous recessions?  Can the Fed reach its target unemployment level by hiking interest rates?  Do we need a job-loss recession to beat inflation?

You may have seen headlines this year about layoffs – mostly in the tech sector:

Amazon cuts 9,000 more jobs, bringing 2023 total to 27,000

Twitter lays off another 10% of staff

LinkedIn will cut over 700 jobs

IBM Announces 3,900 job cuts

Meta is laying off employees for the third time in less than three months

However, these announcements do not appear to be the tip of a job-loss recession iceberg.  Instead, many of these layoffs are the result of over-hiring during COVID.  In fact, these layoffs have not had any significant impact on the overall unemployment rate in the US (more on that below).

The 2023 labor market

The Fed’s stated target for unemployment is 4.5%.  At the time the Fed publicly stated this goal in 2022, the unemployment rate in the US was 3.7%.  Since then, it’s decreased to 3.5%.  That’s right – while the Fed has been hiking rates with the hopes of increasing unemployment in the US, the unemployment rate has gone down.

One look at the data tells us why – in the US, we have over 9.5 million job openings, while we have less than 6 million folks looking for work.  You read that correctly:  We have more job openings than we have people looking for a job!  If the Fed insists on this unemployment goal as part of their fight against inflation, then they’ve got a long way to go, and they could drive us into a job-loss recession that won’t achieve any of its objectives.  

Does the Fed only care about the labor market in its fight against inflation?

With respect to the fight against inflation, the Fed has also stated a target for year-over-year growth of the Consumer Price Index (CPI).  The Fed’s goal is to return to a 2% annual increase for CPI.  Since July 2022, the CPI has been steadily declining.  In fact, the most recent CPI reading showed that prices had increased 3% from the prior year, which means that CPI is rapidly approaching the Fed’s target.  And if the Fed can get CPI down to its target of 2%, it’s very likely that a job-loss recession will not be needed.

Now that CPI is flirting with the target level set by the Fed, will they relent on their persistent interest rate hikes?  Or will they ignore the CPI data and continue to hike rates, intent on pushing the US into a job-loss recession?  If the Fed insists on seeing more unemployment, some analysts believe that the rate hikes will continue until the four-week average of initial jobless claims reaches 336,000.  For reference, the current four-week average of initial jobless claims is 231,000.  In other words, we could be in for even more rate hikes from the Fed if it puts more value on the unemployment rate than the Consumer Price Index.  

What is the labor market stays strong?

If the Fed insists on hiking rates until the labor market breaks – despite CPI rapidly approaching the Fed’s target goal – it’s very possible that there could be an effect on home values.  In the meantime, with each strong labor report, we can expect mortgage rates to continue to rise.

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– Brian