January Jobs Report Contained Hopeful and Worrying News for the Fed

WASHINGTON — Federal Reserve officials have said they are looking for the labor market to cool as they assess how much more they need to do to slow the economy, and the job report on Friday underscored that policymakers may still have a ways to go.

Employers hired ravenously in January, adding 517,000 workers. The jobless rate dipped to a level not seen since 1969, and revisions to last year’s data showed that job growth was even stronger in 2021 and 2022 than previously understood — all signs that the demand for labor is booming.

Yet at the same time, wage growth continued to moderate. Average hourly earnings climbed 4.4 percent over the year, more than forecast in a Bloomberg survey of economists but less than the 4.8 percent year-over-year increase in December. Pay growth has been decelerating for months, though it remains faster than is typical and notably quicker than the pace that Fed officials have at times suggested would be consistent with their 2 percent inflation goal.

For central bankers who are trying to bring down the fastest inflation in decades, the report offered both encouraging and worrying news. On one hand, the continued slowdown in pay increases was a welcome sign that, if it persists, could pave the way for slower price increases down the road. But Fed policymakers who spoke on Friday focused more intently on the fresh evidence that demand for workers remains intense despite their efforts, suggesting that they have more work to do before they will be able to feel confident that rapid inflation will fade fully.

“The biggest surprise — and the thing to take the most signal from — is the combination of the job gains over the past month and the restatement over the past year,” Thomas Barkin, the president of the Federal Reserve Bank of Richmond, said in an interview with The New York Times. “We still have more to do. Inflation is the guidepost.”

Fed officials have already lifted rates from near zero a year ago to more than 4.5 percent, ushering in a quarter-point move just this week. While they have signaled more to come, investors and economists had been betting that they might stop moving after their next meeting, in March.

The strong job numbers upended that expectation. Investors on Friday penciled in another rate move in May, and stocks fell in response to the jobs data as Wall Street braced for a more aggressive central bank. Higher rates weigh on demand by making it more expensive to borrow to buy a house or expand a business.

Fed officials themselves underlined that further rate adjustments are coming.

“The number today on the jobs report was a ‘wow’ number,” Mary C. Daly, president of the Federal Reserve Bank of San Francisco, said on Fox Business. She added that it did not change the economic narrative: It was just additional confirmation that the labor market is strong.

She said the Fed’s December forecast — which called for two more quarter-point rate increases, pushing rates just above 5 percent — remained “a good indicator of where policy is at least headed,” adding that she is “prepared to do more than that if more is needed.”

The Fed usually cheers on workers when they get new jobs and raises. But officials are worried that today’s strong labor market, with its strong wage growth, could stop inflation from returning to their target. When companies jack up pay to compete for a limited number of workers, they may raise prices to cover their climbing labor bills. Beyond that, higher incomes could keep consumers spending more freely.

“The Fed should be very happy that they’ve got some declines in inflation without wrecking the labor market,” said Gabriel Chodorow-Reich, an economics professor at Harvard. But he added, “I don’t think they are going to look at this and think that wage growth is moderating enough for them to be comfortable.”

Price increases are beginning to cool notably, and Fed officials have slowed their rate increases as they wait to see how their cumulative changes are affecting the economy after a year of rapid adjustment. Wall Street is now waiting for clarity on how high officials will push borrowing costs, and how long they will leave them elevated, to ensure that inflation comes fully back under control.

Central bankers have said they are watching the job market as they weigh those choices. Officials had been expecting to see a continued slowdown in hiring as past policy changes took full effect, causing the job market to loosen and wage gains to soften.

“This report goes in the wrong direction,” Mr. Chodorow-Reich said.

In particular, officials may doubt that wage growth can continue decelerating when unemployment is touching its lowest levels in the modern era.

“How far can you push the immaculate wage disinflation story, if you’re getting jobs gains like this?” said Neil Dutta, head of U.S. economist at Renaissance Macro Research. As unemployment falls, he thinks companies will keep bidding up pay as they compete for employees.

Still, the gradual rebound in the number of people working or looking for work — and the fact that pay gains have been easing even as the jobless rate has plummeted — could make some Fed officials question whether they need to slow down the job market as drastically as they had expected. It is possible that a rebounding supply of workers could help fill open positions, allowing the economy to reach a more even keel in which wages gently cool without major job losses.

“There’s still room for the labor market to continue to grow while wages return to a more normal trend,” said Mike Konczal, director of Macroeconomic Analysis at the Roosevelt Institute, a progressive think tank.

The Fed’s normal model for thinking about the economy would not predict slowing wages and inflation alongside dropping unemployment, he noted, even though that is what has happened in recent months.

Regardless, economists emphasized on Friday that it was important to wait for more data, in part because Friday’s figures are subject to revision.

“We just have to be really careful reading too much into any one data release,” said Kristin J. Forbes, an economist at the Massachusetts Institute of Technology and a former Bank of England policymaker. But the data made it clear that the labor market “has legs,” she said, which could make the Fed wary about future wage and price pressures even as inflation itself eases.

“Things have turned and are headed in the right direction, but we don’t know how long things will stay on this path,” Ms. Forbes said. “And we don’t know where they will settle.”