Inflation is the right fight for Federal Reserve, but don’t ignore growing employment

The Federal Reserve’s focus has shifted away from the job market. Investor attention should remain, however, when the January jobs report is released on Friday.

The central bank made official last week what the investment markets already knew and have been nervous about. It is squaring up for a fight against persistent inflation. In March, the Fed is widely expected to raise its target short-term interest rate for the first time in almost four years.

The strong job market and uncomfortably high inflation have made this move necessary. The agency has two statutory goals: steady prices and full employment. Throughout the pandemic, it had the leeway to concentrate on the job market until inflation reared up and started threatening purchasing power of consumers and companies.

The unemployment rate has fallen from almost 15% to below 4% in December. It isn’t quite as low as it was in the months before COVID-19 emerged in March 2020. Still, as Federal Reserve Chairman Jay Powell said last week, “The labor market has made remarkable progress and by many measures is very strong.”

That continued strength will be necessary for the Fed, and the market, to have the conviction to keeping raising interest rates in the months ahead in hopes of tempering inflation. The job market also can be an indicator of inflationary trends and inflation expectations.

Much has been made about the historic drop of the unemployment rate. One reason is the smaller proportion of Americans considered part of the workforce. There were 2.3 million fewer people in the job market in December compared to the month the pandemic began in spring 2020. This is one gauge to watch.

And some of those “missing” workers may reenter the job market because of higher prices they’re experiencing and expecting as consumers, and higher wages companies are offering to hire people. That could in turn could help feed inflation.

“We are attentive to the risks that persistent real wage growth … could put upward pressure on inflation,” Powell said Wednesday.

Inflation is the right fight for the Fed right now. But long-term investors should not discount what is happening in the labor market.