Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why the Fed Watches the Jobs Report's Wage Signal
Transcript
- Lucas: So the July jobs report was a real head-scratcher. The economy lost twenty-three thousand jobs, according to the headline, but the unemployment rate didn't move. That's the kind of data that makes the Fed's job harder, not easier. Luna: Wait, we actually lost jobs? I thought the labor market was supposed to be cooling, not contracting. Lucas: Right, that's the surprise. And it's not just the headline loss. Private payrolls were even weaker, with ADP showing only forty-four thousand private jobs added in July. So you've got two different surveys pointing in the same direction: the labor market is softening faster than most people expected. Luna: That's a big deal for the Fed. If jobs are disappearing, they can't keep rates high for too long, can they? Lucas: Yeah, but here's the twist. The Fed is also looking at wage growth. Average hourly earnings rose at a pace that's still above what's consistent with the Fed's inflation target. So you have a labor market that's cooling on the quantity side, but the price of labor is still sticky. Luna: And we know the Fed hates sticky. They've been burned by that before. Lucas: Exactly. And that's why the wage signal is so important. The Fed can look past a one-month job loss if wage growth is slowing toward a level that aligns with their two percent inflation goal. But if wages stay hot, they have to worry that the inflation fight isn't over. Luna: So what's the actual wage number? Is it slowing or not? Lucas: The latest data shows year-over-year wage growth still hovering around four percent. That's down from the peak of nearly six percent a couple of years ago, but it's still too high for the Fed's comfort. They'd probably want to see it closer to three and a half percent or lower to feel confident. Luna: But with job losses, wouldn't wage growth naturally slow? Supply and demand, right? Lucas: You'd think so, and it is slowing, just not as fast as the Fed would like. And that's the puzzle. The labor market is loosening, but wages are still sticky. Some of that might be because of the mix of jobs lost — lower-wage industries are taking the hit, which pushes the average up. But the Fed can't just dismiss it. Luna: So the Fed is stuck between a weakening job market and sticky inflation. That's the worst spot for a central banker. Lucas: It really is. And to make it even more interesting, the market's inflation expectations are actually rising. The ten-year breakeven rate moved up to two point two six percent this week, from two point two two. That's still below the Fed's target, but it's a sign that investors aren't convinced inflation is dead. Luna: Hmm, that's a mixed message. On one hand, the market is pricing in rate cuts because of the weak jobs data. On the other, inflation expectations are creeping up. That's a contradiction. Lucas: It's not so much a contradiction as it is a reflection of the uncertainty. The market is trying to figure out what the Fed will do next, and the data is genuinely ambiguous. Core PCE is still running above the Fed's target, even though CPI ticked down in June. So the Fed has to weigh these conflicting signals. Luna: And what's the Fed funds rate right now? That's the tool they have. Lucas: The effective fed funds rate is three point six three percent, and the interest on reserve balances is three point six five. So the Fed is holding steady, but the market is starting to price in a cut at the September meeting. The odds have been creeping up after the jobs report. Luna: If they cut in September, that would be a big signal. But wouldn't that risk reigniting inflation if wage growth is still hot? Lucas: That's the debate inside the Fed. Some officials are worried about the lag effect of the rate hikes they've already done. They think inflation will keep cooling, and the risk is keeping rates too high for too long and triggering a recession. Others look at the wage data and say, not so fast — we need to see more evidence that inflation is sustainably on target. Luna: So the wage data is really the crux of the whole thing. It's not just a labor market indicator; it's a leading indicator for inflation. Lucas: Exactly. And that's why we're going to spend this episode unpacking why the Fed watches the wage signal so closely. Because it might be the single most important number in the next few months. Luna: And if you're finding these conversations helpful, honestly, if today's episode was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. Lucas: Yeah, listener support is what keeps this podcast ad-free, so if you're able, that's the best way to make sure we can keep doing this. No pressure, but we appreciate it. Luna: Alright, back to the Fed. So how exactly does the Fed use wage data in its decisions? Is it just watching the monthly average hourly earnings, or is there more to it? Lucas: They look at several measures. The most obvious is average hourly earnings from the employment report, but they also track the employment cost index, which is more comprehensive because it includes benefits. And then there's the Atlanta Fed's wage growth tracker, which uses microdata to give a more detailed picture. The Fed doesn't rely on any single number. Luna: So they triangulate. But what's the actual threshold? Is there a specific wage growth number that would make them comfortable? Lucas: It's not a hard rule, but a rough estimate is that wage growth of three to three and a half percent is consistent with two percent inflation, assuming productivity growth of around one and a half percent. So when wages are running at four percent, that's still above that sustainable level. Luna: That makes sense. But if the labor market is weakening, wouldn't that naturally push wage growth down? Maybe the Fed can just wait. Lucas: That's the hope, and it's what the Fed's forecast implies. But the recent data hasn't shown the kind of sharp slowdown you'd expect. Even with the job loss, wage growth was only slightly lower than the previous month. So the transmission from a looser labor market to slower wage growth is taking longer than expected. Luna: So what would happen if the Fed cut rates and wage growth stayed sticky? Would they have to reverse course? Lucas: They'd be in a tough spot. They could pause further cuts, but reversing a cut is always politically difficult. That's why they're being so cautious. They want to see a clear trend in wage growth before they commit to a rate cut cycle. Luna: And with the breakevens rising, the market is essentially telling the Fed that inflation expectations are creeping up. That's a warning sign. Lucas: Exactly. And that's why the Fed can't just look at the latest CPI print and say, mission accomplished. Core CPI is still above two percent, and core PCE is even stickier. The inflation picture is not fully resolved, even if the headline number has cooled. Luna: So the Fed is walking a tightrope. One wrong step and they could either reignite inflation or tip the economy into recession. Lucas: That's the classic central bank dilemma. And the wage data is the rope itself. If wages cool, they can ease off. If wages stay hot, they have to keep the pressure on. Every jobs report between now and September is going to be scrutinized for that signal. Luna: So what should we watch for in the next few weeks? Any specific data points? Lucas: The next big thing is the CPI report for July, which comes out next week. We'll also get the JOLTS data, which shows job openings, and the Fed's preferred inflation gauge, PCE, later in the month. But honestly, the wage component of the jobs report might overshadow all of that, because it's the clearest read on the labor cost pressure the Fed is worried about. Luna: And if wage growth comes in below three point five percent, that could be the green light for a September cut. Lucas: Right. But if it comes in at four percent or higher, the Fed might have to hold off and let the market down. Either way, the wage number is going to be the one to watch. It's a simple number, but it carries a lot of weight. Luna: It's like the canary in the coal mine for inflation. Lucas: Exactly. And that's why we wanted to break it down today. If you take one thing from this episode, it's that the Fed is not just watching the unemployment rate or the headline job gain. They're drilling into the wage data because it's the best forward-looking signal they have. The next few months are going to be pivotal. Luna: So, regardless of what happens, we'll be here to make sense of it all. Lucas: We will. Thanks for listening, and we'll talk to you in the next one.