The Daily Telegraph - Saturday
Booming US jobs market dampens hopes of summer interest rate cuts
US voters cite the economy as their top priority – but the Federal Reserve has not yet beaten inflation
AMERICA’s booming jobs market has dampened hopes of summer interest rate cuts after a shock jump in US payrolls highlighted the strength of the world’s biggest economy.
The US added 303,000 jobs in March driven by faster hiring in healthcare, construction and leisure and hospitality, according to the Labor Department.
This was up from 270,000 in February and much higher than the 214,000 predicted by analysts.
US borrowing costs spiked as traders pared back bets on imminent rate cuts by the Federal Reserve, which has kept rates on hold at 5.25pc to 5.5pc for five straight meetings. Traders are now pricing in a first interest cut in September, having bet on a move by July.
Paul Ashworth, chief North America economist at Capital Economics, said: “The blockbuster 303,000 rise in nonfarm payrolls backs the Fed’s position that the economy’s resilience means it can take its time with rate cuts.”
The pound dropped sharply following the data, falling as much as 0.7pc against the dollar below $1.26. However, US stock markets moved higher in early trading as the data also showed wage growth slowed to 4.1pc, average hours rose and those in work or looking for a job also increased, reducing inflationary pressure. Average hourly earnings rose by 4.1pc from a year ago, the slowest annual pace since mid-2021.
President Joe Biden welcomed the jobs report. He said: “Three years ago, I inherited an economy on the brink ... We have passed the milestone of 15m jobs created since I took office. That’s 15m more people who have the dignity and respect that comes with a pay check.”
However, Jerome Powell, the Fed’s chairman, has warned that the central bank risks being forced to delay its first cut to interest rates because of stubborn inflation and strong economic growth.
His warning also threatens to derail Bank of England Governor Andrew Bailey’s plans to lower UK borrowing costs, as a significant break with Fed policy risks undermining the value of the pound , pushing up the price of imports.
It is no secret that one of President Joe Biden’s key weaknesses in the upcoming presidential election is the economy. A USA Today/Suffolk
University poll in March put Trump at 40pc, just ahead of Biden on 38pc. The same poll showed many Americans remain undecided. Among those surveyed inflation and the economy were listed as the most important issues determining their vote.
As such, a core problem for Biden is the recent price rises and resultant cost of living crisis. In the past few months, political strategists have marvelled at the fact that the economy under Biden was growing (at 3.2pc in the fourth quarter of 2024) but polling on Biden’s performance on the economy was dismal.
A recent paper led by former Secretary of the Treasury Larry Summers has helped clear up the discrepancy. Summers and his co-authors show that if we adjust American inflation data to consider changes in methodology that have taken place over the past few decades, we see inflation not peaking at 9pc, as the official data indicates, but rather at 18pc. The paper also suggests that inflation measured in line with historical norms would have been 8pc at the end of 2023, not the 3pc shown in the official statistics.
This explains why the average American voter is angry at Biden about the economy: prices are still rising at a rapid clip and living standards have been substantially eroded under his administration. This puts the Federal Reserve in a very unusual position this electoral cycle, because what the central bank does in the coming months could have a huge impact on the outcome of the election.
As late as December of last year, the Fed remained concerned about inflation. The mantra that officials were feeding to markets at the time was “higher for longer”; the idea being that the Fed would maintain interest rates at a high level until there was ironclad evidence that inflation had been tamed.
Then, in mid-December, much to the surprise of market analysts who were naïve enough to simply follow the data, the Fed turned on a dime and started to signal that there would be rate cuts in 2024. This has led many Republicans, perhaps understandably, to start questioning whether the Fed has begun to play politics with monetary policy: lowering rates not because the inflation numbers justify it, but because it might help the incumbent at the White House.
Consider the basic facts. The Fed, like the Bank of England, has a target of 2pc for inflation.
Yet inflation has not been below 2pc since February 2021. As of February 2024, inflation stands at 3.2pc, higher than it was in June 2023 when it bottomed out at 3pc.
So-called “sticky price” inflation less food and energy – a key metric the Fed has been watching to make sure the inflationary vampire will stay in the grave – was at 4.4pc in February 2024. Back in February 2021, this measure was at 1.4pc.
This has been a dangerous game for the Fed. After all, its credibility is currently at an all-time low after it missed the inflation target to begin with, and even once the threat was apparent members thought it was “transitory”. With the Fed signalling rate cuts for four months while the actual data continued to show inflation above target, the central bank was betting the farm that it would fall. Now, however, it appears that the Fed will have to throw in the towel. Oil prices are rising sharply. Brent oil currently stands at more than $90 a barrel, up from just over $73 a barrel in mid-December around the time the Fed started priming the market for rate cuts.
It should have been obvious that oil
‘Trump will not forget the chatter about the Fed playing politics with interest rates’ prices would rise, as the OPEC+ countries led by Russia and Saudi Arabia were signalling aggressive production cuts.
But the Fed ignored oil producers and rode a downward market trend that was facilitated by hedge fund short sellers.
As a result, the Fed has succeeded in annoying almost everyone and looking very silly in the process. Biden looks as if he will not get the rate cut that he effectively promised. Trump will not forget the chatter about the Fed playing politics with interest rates. And the markets will finally have to face the fact that the Fed’s inflation analysis, much less its signalling, is at times unreliable. A credibility crisis has been building around America’s central bank for some time.
Yet because markets have become so enamoured with Fed policy, it is in no one’s self-interest to call it out.
When the Fed asserted that inflation was transitory, for instance, the markets trusted the plan.
After all, it was reasoned, the Fed sets the interest rate which in turn determines the value of bond portfolios in the markets. Rather than question the rate-setter, the path of least resistance was to go with the flow.
And when it turned out that the Fed was wrong about inflation, the rational move was for markets to shrug it off: after all, if everyone got it wrong, then it was obviously unforeseeable.
Two things are now becoming clear. First, that central bank independence in the US is looking less like independence from government and more like independence from serious economic analysis.
Second, that Biden cannot rely on lower interest rates to boost his electoral prospects. If anything, they look more dire than ever before.