The bond market is still thinking about monetary policy through a Phillips Curve frame of mind. On the back of a strong employment report Friday, yields on 10-year Treasury bonds surged to a 16-year high, reflecting the belief that hot labor markets drive inflation and, thus, monetary policy will have to tighten further. Thankfully, the Federal Reserve is moving away from such thinking.
Consider the report itself. US payrolls added 336,000 jobs in September, far exceeding the highest economist forecasts in a Bloomberg survey (high 250,000; median 170,000). The two previous reports were also revised up by 119,000. But crucially, the labor market strength hasn’t been accompanied by renewed signs of upward wage pressure, which can fuel corporate costs—especially in service-related industries—and ultimately higher prices. That meaningfully impacts interpretation of the data, but don’t take my word for it.
Here’s how Randall Kroszner, a University of Chicago professor and former Fed governor, put it on Bloomberg Television with Tom Keene and Lisa Abramowicz (emphasis mine):
Abramowicz: What would you, if you were still on the Fed, do with this?
Kroszner: So I think look at two pieces. One, obviously the incredible strength of the labor market continuing to be there. But the silver lining is that we didn’t see a lot of kick up in wages. So I’d want to get into that in a little bit more detail. Because that’s really ultimately what is going to affect costs and what’s going to drive inflation. Maybe I was being too harsh in saying there would be a hardish landing, maybe we’ve got something that’s perfect Goldilocks. I find it hard to believe. It’s possible. After being at the Fed during the global financial crisis I never say never about anything. But we’ve never seen something so perfectly Goldilocks before. But if you can have a strong labor market but not have real wage growth being too high, that would be ideal for the Fed.
Yes, for anyone trained on the Phillips Curve and economic history, it all seems too good to be true—but for the moment, it’s reality, and members of the Fed’s rate-setting committee have acknowledged as much. Payrolls have been climbing, but wage increases are slowing, in part because of more immigration and increased labor supply and the slow process of rectifying structural shortages in certain sectors. And there’s little concrete evidence that it’s leading to a surfeit of inflationary persistence, much less a re-acceleration.
Total growth in private average hourly earnings slowed to 0.2% on a seasonally adjusted monthly basis. While it’s not the most representative gauge of wage pressures, it’s timely, and the positive signals are hard to ignore. Calculated based on the past three months of seasonally adjusted data, average hourly earnings are now increasing at a 3.4% annual rate—the slowest since 2021 and broadly consistent with the Fed’s goals (assuming 1.5% productivity growth and 2% inflation, earnings should grow at around 3.5%). The slowdown in average hourly earnings was broad-based as well, cooling from the previous month in six of 10 main categories.
Understandably, policymakers don’t want to take for granted the belief that this ideal scenario will continue, and their caution is certainly warranted. But fortunately, they won’t be goaded into tightening monetary policy simply because they have a hunch that headline payroll numbers are going to suddenly become relevant to inflation again.
Here’s Fed Chair Jerome Powell on the issue at his press conference on Sept. 20 (emphasis mine):
It is a good thing that we, we’ve seen now meaningful rebalancing in the labor market without an increase in unemployment, and that’s, that’s because we’re seeing that rebalancing in other places—in, for example, job openings and in the jobs–worker gap. You’re also seeing supply-side things—so, so that’s happening. I would say, though, we still—I still think, and I think, broadly, people still think, that there will have to be some softening in the labor market that can come through more supply, as we’ve seen as well. ...
Austan Goolsbee, the new Federal Reserve Bank of Chicago president who is seen as a dove on the rate-setting committee, put it most bluntly in a speech last week:
[The] traditional approach leaves us with a puzzle. Core inflation began moving down. ... And it did so while the job market was still strong—not after it had already weakened substantially. For the traditionalist, the answer is that it must be noise. ... But another answer is that something very different is going on: Either nonmonetary shocks are heavily influencing the economy or the nature of the monetary policy environment we are working in today is different. I believe both of these factors are at play. If so, we need to be extra careful about indexing policy to this traditional view of what the incoming data on output and the labor market mean for the inflation outlook.
Putting the pieces together, I don’t think that Fed policymakers are any more likely to raise interest rates today than they were before they received the payroll numbers. There’s still clearly a chance that they will raise rates by another quarter point—as was already projected by the median forecast in their Summary of Economic Projections—but a lot of countervailing forces are at play in determining whether that happens. Even if there are still some Phillips Curve traditionalists on the Fed’s rate-setting committee, I suspect Friday’s numbers are more than offset by other factors. The rise in longer-term bond yields itself, for instance, mitigates to a degree the need for more rate increases and may weigh more heavily than a single government jobs report.
In fairness, the wild price swings in bond markets aren’t just about the latest data. Deep fiscal deficits and a jump in Treasury supply have left the market on edge, and traders are especially skittish, and their fears of structurally higher interest rates have been stoked by recent comments from the likes of Bill Ackman and Jamie Dimon. But the Fed is not going to raise rates over strong payroll data on the basis of an economic idea born in the 1950s—especially when the empirical evidence to date keeps defying its basic precepts.
Jonathan Levin is a columnist focused on U.S. markets and economics. Previously, he worked as a Bloomberg journalist in the U.S., Brazil and Mexico. He is a CFA charterholder.