Job growth expected to have cooled in December but not enough to slow Fed rate hikes

The economy is expected to have added 200,000 jobs in December, less than November, but still strong enough to keep the Federal Reserve aggressively tightening policy to fight inflation.

Economists surveyed by Dow Jones also expect that the unemployment rate remained at 3.7% in December, while average hourly wage growth slowed to 0.4% from 0.6% in November. There were 263,000 jobs added in November.

The employment report is scheduled to be released Friday at 8:30 a.m. ET, and it is the last major monthly jobs data before the Fed meets Jan. 31 and Feb. 1.

The data is important since the Fed has been trying to slow the hot labor market in its fight against inflation. The central bank has raised interest rates seven times in this tightening cycle, and economists say it could hike by another half-percentage point in February, but traders in the futures market are betting on just a quarter-point hike.

“I still think we’re in for a solid number on Friday. I don’t think things have slowed all that much,” said Michael Gapen, chief U.S. economist at Bank of America.

Gapen expects 215,000 jobs were added last month. “That’s twice as much job growth as they want.” December’s report could still show some gains from seasonal hiring.

The Fed’s latest economic forecast shows unemployment climbing to 4.6% by the fourth quarter. “Their forecast has the unemployment rate rising. We know the breakeven rate is somewhere between 70,000 to 100,000,” Gapen said. “If you need the unemployment rate to rise, you need jobs to fall below 70,000 to 100,000.”

Gapen expects the monthly number could start to turn negative in the first half of the year, and then continue to be negative for awhile.

“Right now the underlying economy is where we’re looking for evidence to suggest whether the slowdown has broadened beyond housing and nonresidential construction investment,” he said. “The next likely place should be the goods side of the economy.”

The Fed is willing to have the job market weaken because officials see worse damage for the economy if they let inflation remain high, Gapen said. He is looking at construction as one area that could give up jobs, as the real estate slowdown ripples across the economy.

“We have a large number of homes under construction. … We’ll look for mortgage service lenders and realtors … people who are framers and foundation layoffs. That’s probably where you’ll see layoffs first in construction,” he said.

Aneta Markowska, chief financial economist at Jefferies, expects 175,000 jobs were added, but she is most concerned about the continued pressure on wages. She agrees with the consensus that wages grew in December by 0.4%, or 5% year over year, but says that number could jump to as high as 0.7% on a monthly basis in January, as companies implement raises.

Economists worry that wage inflation, should it begin to spiral, is a type of inflation that is more difficult to eradicate. The strength in the labor economy has been surprising economists for months. Job openings in November, for instance, were reported at nearly 10.5 million, more than expected, when the Job Openings and Turnover Layoff Survey was released Wednesday.

“I think what the JOLTs data told us is that actually there is a slowdown in hiring. It’s not because demand for labor is declining rapidly,” said Markowska. “It’s just the supply constraints are starting to bite. You’re seeing the quits rate go up again. Growth hires are still solid. … We’re potentially running into more binding constraints in the labor market, and if that’s the case, we’re in for more upside in wages.”

Diane Swonk, chief economist at KPMG, said an area that has shown an increase in hiring is new companies.

“Much of what we’re seeing is being driven on the demand side, not just by employers, but by new business formation, which they’re all of a sudden having to compete with,” she said. “It’s a very different situation than we’ve seen in the past.”

The Fed has raised interest rates seven times since last March, and the fed funds rate is now at 4.25% to 4.5%. Both Gapen and Markowska said the strength in labor warrants the central bank raising rates by another half-percentage point on Feb. 1, and then a quarter point in March. Many investors, however, expect just a quarter-point hike in February and then another quarter point after that.

Mark Zandi, chief economist at Moody’s Analytics, said the Fed is trying to encourage investors to expect higher rates for longer. That was evident in the minutes from its December meeting, released Wednesday.

“I think they are trying to guide markets from thinking rates are going to come down quickly this year,” he said. “If you look at market expectations, the fed funds rate comes up to 5% shortly and then comes back down quickly in the back end of the year. The message in the minutes is rates are going to be higher for longer. Who knows at the end of the day if they are going to keep rates that high for long, but that’s the message they wanted to send.”

Zandi expects the economy added 225,000 jobs in December.

“The job market is slowing steadily, but surely. It’s not enough. The Fed, I think, would love to see job gains south of 100,000, closer to zero, to get unemployment moving north and wages moving south. These numbers suggest we’ll quickly be moving in that direction,” he said. “I think we’ll be at 100,000 in the spring and there will be months at zero on the spring or summer.”

Because of its potential impact on the Fed, the jobs report could move the markets.

“I’d look at wages first and foremost. If jobs comes in at 250,000 or 300,000, I don’t think the market reacts too much,” said Michael Schumacher, head of macro strategy at Wells Fargo. “If the wage side of it comes in at 0.5, or 0.6, that’s pretty disruptive. 0.3 is a nonevent. The market needs a 0.2 to move a lot, and then the narrative kicks in that the Fed is almost done.”