MNI POLICY: Fed Sees Jobs On Shakier Ground Amid Tariff Shocks

The U.S. labor market encounters President Donald Trump's trade policy shocks on increasingly shaky ground, but it will take significant deterioration in employment conditions for the Federal Reserve to overcome inflation worries and resume interest rate cuts. 

Cooling demand will likely manifest as layoffs rather than the fewer job openings seen in 2022 and 2023, the last time the labor market slowed significantly. In 2022, the Fed increased the policy rate by 75 basis points at four consecutive meetings in response to the pandemic inflation surge, and the central bank argued there would be limited feedthrough to unemployment that would allow a soft landing. 

But in March, the ratio of job vacancies to unemployed people stood at 1, the lowest in four years and below the average in the year before the pandemic. The ratio implies that the impact of lower labor demand going forward is more likely to manifest in higher unemployment.

For the moment, though, headline figures still provide little cause for alarm, and remain too robust to give policymakers cover for further rate reductions. The three-month average pace of hiring at 155,000 is still above estimates of the breakeven rate. While the unemployment rate has risen from a 50-year low to 4.2%, it is still low in historical terms. Nonetheless, any sharp deterioration in employment could lead to a reassessment of the risks to the Fed’s goals under its dual mandate.

STARTING POINT

"While job growth has slowed relative to last year, the combination of low layoffs and lower labor force growth has kept the unemployment rate in a low and stable range," said Fed Chair Jerome Powell in Chicago last month. "Unemployment is likely to go up as the economy slows in all likelihood and inflation is likely to go up as tariffs find their way," he said in Q&A. 

"As we act to meet that obligation, we will balance our maximum employment and price-stability mandates, keeping in mind that, without price stability, we cannot achieve the long periods of strong labor market conditions that benefit all Americans," Powell said. (See: MNI INTERVIEW: Fed On Hold Until Tariff Pause Passes- Lockhart)

The labor market tightness that continued to drive inflationary price pressures into 2023 is no longer present. 

The twelve-month change in average hourly earnings has slowed from its peak of about 6% in March 2022, to 3.8% as of April. Growth in the Employment Cost Index has edged down to 3.4%, extending the gradual cooldown since 2022 though still above the pre-Covid trend.

Though Chair Powell last month said that over the last year the growth of labor supply has stagnated, due in large part to shifting immigration policies, he noted an "in tandem" decline in demand for workers. 

LESS FLEXIBILITY

Job openings peaked at an all-time high of 12.1 million in March 2022. Since then, openings have fallen by 41% and the openings rate has dropped by 3.1 percentage points. As of March, the quits rate ticked up a notch to 2.1%, but remains below its pre-pandemic average pace of 2.3%. The hiring rate stayed at 3.4% and the layoff rate edged down to 1.0%.

The recent increase in unemployment has also been driven in part by a slide in the job-finding rate, with signs of less flexibility within the labor market.