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US job growth slows as Fed tightening takes effect

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US job growth slowed for the fifth consecutive month in December after aggressive interest rate hikes by the Federal Reserve squeezed economic activity, even as the US job market remains historically tight.

The world’s largest economy added 223,000 jobs in the last month of 2022, down from the downwardly revised increase of 256,000 recorded in November and well below last year’s peak of 714,000 in February. Most economists expected an increase of 200,000.

After the December surge, monthly job growth averaged 375,000 in 2022. The number of jobs added has dropped every month since August.

Despite the slowdown in the pace of job growth, the job market still shows resilience that will probably force the Fed to continue raising interest rates this year.

The unemployment rate unexpectedly dropped to 3.5%, returning to an all-time low, data released by the Bureau of Labor Statistics showed.

“This is still a very tight job market,” said Veronica Clark, an economist at Citigroup. “To an economist, a low unemployment rate [is] future upside risks to wages”.

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However, the slowdown in wage growth in December helped spark a stock market rally as investors bet that the Fed would not need to be as aggressive with its tightening policy towards the end. Equities were further boosted by a sharp drop in services activity, according to ISM data released on Friday. The S&P 500 was up 1.6% in late morning trading in New York, while the Nasdaq Composite was up 1.4%.

The two-year Treasury yield, which is sensitive to changes in interest rate expectations, fell 0.19 percentage point to 4.26%, marking a sharp rise in the debt instrument’s price. The yield on the benchmark 10-year Treasury note, seen as a proxy for borrowing costs around the world, fell 14 percentage points to 3.58%.

The US central bank is actively trying to cool the job market and reduce demand for new hires, while seeking to ease price pressures that have driven inflation to multi-decade highs. Since March, the Fed has raised its benchmark interest rate from nearly zero to just under 4.5%, in one of the most aggressive campaigns in its history.

While the worst of the inflationary shock appears to be over, price pressures have taken hold in the services sector of the economy. In an interview with the Financial Times this week, Gita Gopinath, the IMF’s first deputy managing director, urged the Fed to “stay the course” in terms of tightening, arguing that US inflation “has not yet turned the corner”.

In comments on Friday, Fed governor Lisa Cook warned against “putting too much weight” on recent inflation data that she said looked “favourable”. She said she was “watching closely” labor costs, which she said were crucial to the future path of inflation.

Amid a shortage of workers that Fed officials warn will not be easily reversed, wage growth is still at a pace a long way from the Fed’s 2 percent inflation target.

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In December, average hourly wages rose a further 0.3%, less than expected and slower than the previous period, which was revised downwards. On an annual basis, it is 4.6 percent. The labor force participation rate, which tracks the proportion of Americans employed or looking for a job, was little changed at 62.3%.

Evercore’s Peter Williams said the wage data should give the Fed “comfort that inflationary pressures have peaked”.

The biggest job gains occurred in the leisure and hotel sector, with 67,000 jobs created in December. Healthcare employment increased by 55,000, while the construction industry gained 28,000 jobs.

Among the sectors with minimal job gains were retail, manufacturing, and transport and storage.

In a statement released after the report, President Joe Biden said the latest job gains reflect “a transition to steady, steady growth.”

“These historic jobs and unemployment gains are giving workers more power and American families more breathing room,” said the US president, amid a “tightening cost of living”.

Fed policymakers have recognized that ending inflation will require job losses and, in turn, a higher unemployment rate. According to the latest individual projections published by the Fed, most policymakers see the unemployment rate rising to 4.6% this year and next as the benchmark interest rate breaches 5% and holds for an extended period. .

“Containment [above 5 per cent] until we have evidence that inflation is actually going down is really the message we’re trying to get across,” Esther George, outgoing Kansas City Fed president, said on Thursday.

In a similar tone this week, Neel Kashkari of the Minneapolis Fed said he expected the central bank to raise the federal funds rate by another percentage point in the coming months. He will be a voting member of the Federal Open Market Committee that sets policy this year.

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Federal funds futures traders expect the Fed to advance towards the so-called “terminal” level in smaller increments than the half-point and 0.75 percentage point increases it used during this tightening campaign. According to the CME Group, the odds of a quarter point increase at the February meeting currently stand at 65%.

If the Fed goes ahead with its plans, economists warn that more material job losses could be on the horizon. Respondents last month to a joint survey by the Financial Times and the Initiative on Global Markets at the University of Chicago Booth School of Business predict the jobless rate will reach at least 5.5% next year as the economy go into recession.

Additional reporting by Harriet Clarfelt in New York