Key takeaways

  1. U.S. jobs market remain strong with net job gain of 311,000 in February
  2. Wage growth slowed to 3.2%, slightly faster than the 3.1% rate from 2017-2019
  3. Consumer Price Index rose 0.4%, with core CPI excluding shelter growing at a 1.86% rate
  4. Events surrounding Silicon Valley Bank could cause banks to build up cash reserves instead of lending, reducing businesses’ ability to hire and expand
  5. Fed likely won't pause hiking rates this month, but may telegraph a pause in May, making March the last hike of the cycle

The U.S. jobs market remains very strong, but unfortunately, inflation remains too high. In February, the economy added 311,000 new jobs, topping expectations. The Consumer Price Index was also higher than expected on just about every critical metric.

Given the events surrounding Silicon Valley Bank last week, this combination of data puts the Federal Reserve in a difficult position.

Labor market cools from January, but still strong

The 311,000 net job gain in February came as something of a relief to investors. The January jobs report showed growth of 517,000, which stoked worries that the labor market was accelerating.

Gains of 500,000 suggests a jobs market far too strong for the Fed’s liking. Had the employment figures remained that high, it could have resulted in another significant spike in interest rates.

While 311,000 is also probably stronger than the Fed would like, it is consistent with the pace of job gains in the second half of 2022, which averaged 354,000 jobs per month.

Jobs wage growth

Source: Bureau of Labor Statistics

There were a few reasons to suspect that the pop in January employment was a one-off, and this report is yet more evidence supporting that case.

Wage growth has slowed

Perhaps more encouraging for inflation is that wage growth was tepid. According to Bloomberg, average Hourly Earnings rose 0.24% for the month, slightly below economists’ expectations.

Despite the labor market being as strong as it has been, wage growth has slowed materially in recent months. During calendar 2021 and 2022, Average Hourly Earnings grew at a 5.0% annualized pace but have only risen at a 3.2% rate the last two months. Note: that is only slightly faster than the 3.1% average pace from 2017-2019. 

Slower wage growth is key for bringing down inflation. Inflation occurs when consumer spending outpaces the economy’s ability to supply goods and services. Consumers can only keep spending more if their income keeps growing. If wage growth can revert to a more normal pace, then eventually, so will inflation.

Consumer prices still accelerate in February

Unfortunately, this slower wage growth hasn’t translated into better inflation numbers just yet. The February Consumer Price Index report showed that prices rose 0.4% overall. The “core” number, which excludes food and energy, was +0.5%. That’s up from 0.4% last month and 0.1% higher than expected, according to Bloomberg’s economist survey.

As has been the case for the last few months, CPI is skewing higher due to the “shelter” component. We know that new transactions in “shelter,” (i.e., home sales or new leases on apartments), have been declining in price for the last few months. 

However, because the CPI metric uses an estimated average price across all apartments and homes, the lower price of new transactions takes a long time to flow into the CPI. If we took Core CPI excluding shelter, that figure was 0.15% this month. Translated into an annual figure, that’s a 1.86% pace (i.e., under the Fed’s inflation target).

Time will tell where shelter CPI ends up. However, we think it is quite likely that shelter inflation will eventually be close to zero, given the recent declines in home prices and new rental agreements. If that’s the case, and everything else remains the same, inflation will move toward the Fed’s target without requiring more economic weakness.

What could this mean for the Fed next week?

The events surrounding Silicon Valley Bank are a big deal and are no doubt at the center of the Fed’s mind. While we do not think there will be a large number of bank failures, these kinds of events tend to make banks more cautious. For example, a bank may prefer to build up cash reserves to guard against future customer withdrawals instead of increasing lending. If banks lend less, businesses will be less able to hire, expand, etc. This is something the Fed will be watching closely.

That being said, given the strength of the labor and CPI numbers, we don’t think the Fed will likely pause raising interest rates this month. They may very well telegraph a pause in May, though; therefore, there is a good chance that March is the last hike of this cycle.