Fed Remains Patient on Future Rate Cuts as Job Gains Pop

Key Takeaways:

• The Federal Open Market Committee (FOMC) held the federal funds rate at its current target range of 5.25-5.5 percent at its January 30-31 meeting. The Fed’s policy statement dropped its tightening bias in favor of noting that the risks to achieving employment and inflation goals “are moving into better balance.” However, in his press conference, Chair Powell noted that a cut in rates at their March meeting was unlikely.
• Nonfarm payroll employment increased by 353,000 in January following a significant upward revision of 117,000 jobs added in December, according to the Bureau of Labor Statistics (BLS). Additionally, the annual benchmark revision process resulted in only modest changes to estimates of the size of the labor force and showed that job gains accelerated toward the end of 2023. The unemployment rate was 3.7 percent for the third consecutive month and the labor force participation rate was flat at 62.5 percent. Average hourly earnings jumped 0.6 percent, the strongest monthly gain in two years.
• The Job Openings and Labor Turnover Survey (JOLTS) showed that job openings rose by 101,000 to 9.0 million in December, according to the BLS. The quits rate was constant at 2.2 percent, one-tenth below its pre-pandemic level. Layoffs and discharges remained at a low level of 1.6 million, roughly 200,000 below the 2019 average.
• Nonfarm business productivity increased at a 3.2 percent annualized rate in Q4 2023, the third consecutive quarter with annualized productivity growth above 3 percent, according to the BLS.
• The Employment Cost Index (ECI), a measure of labor compensation, increased 0.9 percent in Q4 2023, a deceleration of two-tenths compared to the third quarter, according to the BLS. Compared to a year ago, the ECI was up 4.2 percent.
• The ISM Manufacturing Index increased 2.0 points to 49.1 in January, its highest level since the index dropped below the expansionary threshold of 50 in November 2022. The new orders index, which tends to be more forward looking, jumped 5.5 points to 52.5, its highest level since May 2022. However, increases in the supplier deliveries index and the prices paid index, the latter of which rose 7.7 points to 52.9, may indicate that the shipping disruptions around the Red Sea are leading to worsening supply chain conditions.
• The Conference Board Consumer Confidence Index increased 6.8 points in January following a 7.0-point gain in December, resulting in the highest reading since December 2021 at 114.8. Confidence in the present situation jumped 14.1 points to 161.3, its highest level since before the pandemic, while expectations for the future rose 1.9 points to 83.8.
• The FHFA Purchase-Only House Price Index increased a seasonally adjusted 0.3 percent in November. On a non-seasonally adjusted basis, home prices rose 6.6 percent compared to a year ago.

Forecast Impact:

Employment gains were above our expectations in January, and the upward revision to December suggests that it isn’t an unusually strong one-off report. While at first glance it looks as though the household survey once again diverged significantly from the payroll survey with a reported loss of 31,000 jobs, this was due entirely to an annual update to the population control measure; removing that effect shows household employment increased by 239,000 over the month. Further, the robust wage growth points to the labor market remaining hot.

Still, the ECI, which provides one of the broadest measures of labor market compensation available, suggested that inflationary pressures from wages cooled in the fourth quarter to an annualized rate that would be broadly consistent with 2-percent inflation given typical levels of productivity growth. Productivity growth has actually been better than typical over the past three quarters, which could explain why economic growth has been able to remain robust while inflation has cooled. Still, productivity is difficult to measure and is prone to large swings from quarter to quarter. While this week’s data points to upside risk to our economic growth outlook for 2024, we continue to believe growth will decelerate in 2024.

Other economic data was generally positive this week, with consumer confidence continuing to gain and the ISM manufacturing index indicating the significant contraction in that sector may be over. However, the increase in the prices paid index is concerning and indicates that the recent disruptions to shipping operations in and around the Red Sea may reignite price pressures for some goods. These and other inflationary risks that stem from strong economic growth and a hot labor market are part of the Fed’s calculation, and their statement indicated they would need to gain “greater confidence that inflation is moving sustainably toward 2 percent” before lowering rates. As such, we continue to believe that the first cut in the federal funds rate will be in May, though the jobs report and other economic data add some risk that policy easing will ultimately begin later in the year.

Nathaniel Drake
Economic and Strategic Research Group
February 2, 2024

Opinions, analyses, estimates, forecasts, and other views of Fannie Mae's Economic and Strategic Research (ESR) Group included in these materials should not be construed as indicating Fannie Mae's business prospects or expected results, are based on a number of assumptions, and are subject to change without notice. How this information affects Fannie Mae will depend on many factors. Although the ESR group bases its opinions, analyses, estimates, forecasts, and other views on information it considers reliable, it does not guarantee that the information provided in these materials is accurate, current, or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially different results. The analyses, opinions, estimates, forecasts, and other views published by the ESR group represent the views of that group as of the date indicated and do not necessarily represent the views of Fannie Mae or its management.