Here’s why the strong January jobs report will push interest rates higher

The Federal Reserve is on track to extend its aggressive rate hike campaign and put more pressure on the U.S. economy after a stunning January jobs report, top officials said this week.

Federal Reserve Chairman Jerome Powell said Tuesday that the Fed has a “significant road ahead” to bring inflation down to the bank’s 2 percent annual target after the U.S. added a whopping 517,000 jobs in January and pushed the jobless rate down to 3.4 percent, the lowest level since 1969.

“There’s been an expectation that it will go away quickly and painlessly, and I don’t think that’s guaranteed,” Powell said of high inflation Tuesday during an event at the Economic Club of Washington, D.C.

“The base case for me is that it will take some time, and we’ll have to do more rate increases. And then we’ll have to look around and see whether we’ve done enough,” he said.

The Fed raised interest rates by a quarter of a percentage point last week to reach a range of 4.5 to 4.75 percent. It was the smallest rate hike since the central bank began raising rates in March, as inflation has been coming down. 

At the time, Powell and Fed officials suggested the bank may not have many more rate hikes in store after steady progress against inflation.

The consumer price index has fallen steadily over the past six months to 6.5 percent annually, and the personal consumption expenditures price index, which is the Fed’s preferred measure of inflation, has fallen to 5 percent annually.

But the underlying strength of the economy as shown in the January jobs report could be a problem for the Fed, which has been expecting to see more people losing their jobs as it increases borrowing costs.

The Fed is projecting the unemployment rate to rise to 4.6 percent by the end of 2023, according to projections released in December, a spike that would likely claim millions of U.S. jobs. The higher the Fed pushes interest rates, the harder the U.S. economy could slip into a downturn or recession.

“This process is likely to take quite a bit of time. It’s not going to be … smooth. It’s probably going to be bumpy. And so we think that we’re going to need to do further rate increases, as we said,” Powell said.

Other members of the Fed’s rate-setting committee also took a more hawkish stance on future hikes this week.

“It’ll probably mean we have to do a little more work,” Raphael Bostic, president of the Federal Reserve Bank of Atlanta, told Bloomberg News on Monday. “And I would expect that that would translate into us raising interest rates more than I have projected right now.”

“I haven’t seen anything yet to lower my rate path,” echoed Minneapolis Fed President Neel Kashkari on CNBC Tuesday morning. “Right now I’m still at around 5.4 percent.”

That’s higher than the Fed’s current median projection of 5.1 percent for where interest rates will end up later this year.

While prices for many goods have fallen for months, Kashkari emphasized that he wants to see prices coming down in the core services sector of the economy. Prices in the service sector are heavily influenced by the strength of the labor market, which gives consumers more money to spend and jobseekers more power to ask for higher wages.

“Core services [excluding] housing, that’s a big part of the economy. We’ve seen no progress so far, virtually no progress in core services [excluding] housing, and that’s very tied to the labor market,” he said.

Some economists critical of the Fed’s approach disagree and are accusing the bank of cherry-picking data.

“Goods prices will be flat or falling. Rent inflation is slowing sharply and may even show deflation before 2023 is out. I’m sure there will be some components where inflation is a problem, but that is always true,” economist Dean Baker of the left-leaning Center for Economic Policy and Research told The Hill.

“It seems to me the best course for the Fed is to hold off on further hikes until we get a clearer picture of the data. The January jobs numbers really blew people away, but I’m not sure they are right,” Baker added.

International economists have also been cautioning central banks against over-tightening monetary policy, arguing that they could drive the global economy into an unnecessary recession.

“Overtightening of monetary policy would drive the world economy into an unnecessarily harsh slowdown,” economists with the United Nations Department of Economic and Social Affairs wrote in an economic prospects report released last month.