Jobs, Not Inflation, Will Ultimately Be What Forces the Fed

(Bloomberg Opinion) -- Debate has intensified in the past several months over whether the elevated level of inflation will lead the Federal Reserve to tighten monetary policy sooner than expected: winding down asset purchases followed by an increase in interest rates. The standard pushback has been to blame much of the rise in prices on supply-chain bottlenecks that should abate over time — and besides, the Fed needs to stay the course in order to ensure the labor market fully heals. 

But as the October jobs report showed, the labor market improvement is accelerating again, and we're closer to measures of full employment than generally appreciated. By the middle of next year it will be a robust labor market, not inflation, that leads the Fed to begin raising interest rates.

If you've tempered your outlook on the labor market recovery over the past few months, the October jobs report should make you reevaluate. It wasn't just that job growth was its strongest since July, but prior months were revised up as well. For instance, we now know that the level of employment in August was 286,000 jobs higher than we thought when the August jobs report was released in early September. So as the impact of the Covid-19 Delta variant declined across the country, the job market was accelerating over the summer from a higher level than we thought.

This is significant when thinking about the pace of the recovery projected through the middle of next year. In the first 10 months of 2021, the headline unemployment rate fell to 4.6% from 6.7%, an improvement of about 0.2% per month. If we continue at that pace through the middle of next year, we'll have a 3.0% unemployment rate by June, a full half-percentage point lower than we had at the onset of the pandemic and the lowest level in almost 70 years.

It's a similar story for the under-employment rate that takes into account people working part-time for economic reasons. That rate has fallen to 8.3% from 11.7% this year, for an improvement of more than 0.3% per month. A similar pace of improvement would get it to record lows by the middle of next year.

The metric that generates the most controversy is the prime-age employment rate, or the percentage of people between the ages of 25 and 54 who have jobs. That rate has increased to 78.3% from 76.3% this year — the same 0.2% monthly improvement that we've seen with the headline unemployment rate — but continuing at that pace would only get it back to around 80% by mid-2022. That would still be a half-percentage-point lower than it was in January 2020, in large part because people who have left the labor market have not yet come back.

Both the Federal Reserve and private-sector economists have been skeptical about all of these workers returning, at least in the short-term. Goldman Sachs Group Inc. noted that most of the people who exited the labor force are over the age of 55, outside the "prime age" zone, but it's not clear whether even younger workers can be drawn back in quickly.

In the 2010's we saw that, beginning in 2016, the tightening labor market was leading to more labor-force participation, but the rate was typically not more than 0.5% per year. The Fed might decide now that the labor market is strong enough to drive participation higher over time, with the awareness that there's a "speed limit" to how fast it will occur.

The key idea is that full employment — or employment at least on par with what we had in early 2020 — is coming sooner than we expected. If the labor-market recovery in the 2010's was happening at a speed of, say, 15 miles per hour, today's recovery is happening at more like 60 mph.

The Fed has downplayed the significance of inflation because there was so much more labor market improvement still needed. But the kind of labor market they're looking to see is getting here fast — probably by the middle of next year. And then, let the interest-rate increases commence.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Conor Sen is a Bloomberg Opinion columnist and the founder of Peachtree Creek Investments. He's been a contributor to the Atlantic and Business Insider and resides in Atlanta.

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