The strong pace of U.S. job growth cooled in September, but the unemployment rate unexpectedly fell, reinforcing expectations that the Federal Reserve will raise interest rates by 0.75 percentage points at its next meeting in November.
The world’s largest economy added 263,000 jobs last month, down from 315,000 in August and well below July’s gain of 537,000, according to the Bureau of Labor Statistics. Average monthly job growth is 420,000 through 2022, down from 562,000 in 2021.
Despite the slowdown in growth, the unemployment rate edged back to a pre-pandemic low of 3.5% as the proportion of Americans who were employed or seeking a job dipped slightly.
“The story is that there’s probably a 0.75 percentage point hike in November,” said Tiffany Wilding, North America economist at Pimco. “The Fed needs to keep tightening.”
Fed officials are actively discussing whether a fourth sharp rate hike in a row is necessary next month, or whether they might switch to raising rates in half-point increments. So far this year, the Fed has raised its benchmark policy rate from near zero to a range of 3% to 3.25%.
At issue is how resilient the U.S. economy is and whether inflation is starting to return to the Fed’s 2 percent target.
Friday’s report highlighted that despite recent signs that employers are starting to scale back hiring, the labor market remains fairly strong.
Earlier this week, new data showed that companies cut more than 1 million job openings in August — one of the biggest monthly declines in 20 years. This lowered the ratio of job openings to unemployment from 2 to 1.7.
However, the turnover rate of workers remains high, suggesting that labor supply and demand remain out of balance.
Traders in the federal funds futures contract on Friday expected a 0.75 percentage point rate hike to 82% next month, up from 75% before the latest jobs report, according to CME Group data.
In early Wall Street trade on Friday, the S&P 500 fell 2.2% and was little changed ahead of the data. The two-year U.S. Treasury yield, which is sensitive to changes in policy expectations, rose 0.06 percentage point to 4.31%.
Friday’s data provided further confirmation that the Fed’s “pivot” isn’t coming anytime soon, according to Alex Veroude, chief investment officer of fixed income at Insight Investment.
Officials insisted this week that they have not yet considered pausing or scaling back austerity plans, even as the financial system begins to show signs of stress and the global economic outlook deteriorates.
Worryingly, the labor market is still hobbled by a shortage of workers. As of September, the so-called labor force participation rate was still below the pre-pandemic level of 62.3%. The overall workforce also fell by 57,000.
Leading the job growth was the leisure and hospitality sector, which added 83,000 jobs, followed by health care employment, which rose by 60,000. Construction and manufacturing also continued to add jobs, while the number of transportation jobs declined.
Average hourly earnings in September rose at the same 0.3% pace as the previous period, which equates to an annual increase of 5%.
A persistently tight labor market — and the accompanying wage growth as companies try to attract new workers and retain older workers — is a top concern for the Fed, which is actively trying to dampen demand with outsized interest rate hikes and reduce price pressure.
By the end of the year, most officials forecast the federal funds rate to hover between 4.25% and 4.5%, with further hikes in early 2023. The benchmark policy rate is expected to peak just above 4.5%.
Officials expect their efforts to rein in the worst inflation in 40 years will require not only a sustained period of “below trend” growth but also job losses. Federal Reserve Chairman Jay Powell recently warned that a recession cannot be ruled out.
According to the Fed’s latest forecast released last month, policymakers’ median forecast for the unemployment rate showed it would rise to just 3.8% by the end of the year, before jumping to 4.4% in 2023 and remaining there until 2025.
Officials insist that inflation can be contained without a sharp rise in unemployment, especially since employers may be reluctant to lay off workers because of the magnitude of labor shortages since the outbreak.