All told, the improvement in the inflation and wage data (see US Chartbook, published earlier today) – combined with the services ISM and Credit Managers’ indices – suggest the Fed will slow to just two more 25 basis point hikes this year.
But the market should not be pricing in rate cuts in 2023. The 2-year Treasury yield fell from 4.50% to below 4.30% on Friday. This rally looks overdone. The Fed will want to keep the federal funds rate at 5% for some time, for the U3 rate to at least rise above its longer run estimate of the unemployment rate, a proxy for the NAIRU (currently estimated at 4% in the latest SEP).
The U3 rate fell sharply from 3.65% to 3.47% in December. Critically, the U6 rate hit a new low of 6.5%: the labour market is tight as a drum.
The US added 223k payrolls in December. Seen in isolation, the rate of payroll growth is slowing.
But the ‘breakeven’ payrolls rate – i.e., the average monthly change in payrolls required to keep the unemployment rate constant at 3.5%, given a constant LFPR – has fallen too, now just +87k.
The US economy is currently generating jobs well above this breakeven, falling even further below its NAIRU.
