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Market Update

Don't Be Fooled--the Jobs Market Is Strong

The December jobs report may seem muddy, but it's strong enough for the Fed to start raising rates.

At first glance, December's employment report looks weak, with just 200,000 new jobs added during the month. But it isn't.

The headline number obscures the story of an otherwise tight jobs market where employers are having a tough time finding workers and wages are rising.

It’s an underlying picture that likely sets the stage for the Federal Reserve to start raising interest rates, potentially before the end of the first quarter. The odds of a federal-funds rate increase is now at 70% for the March policy-setting meeting, according to the CME FedWatch Tool. One month ago, those odds were 30%.

“Today's report nudges them further toward an early rate increase,” says Preston Caldwell, Morningstar’s chief economist.

The reason for the muddy picture is that the monthly employment report consists of two parts: the “household survey,” which is the source of the unemployment rate data, and the “establishment survey,” from which the widely followed nonfarm payroll employment statistic is sourced.

Normally, the two portions of the report track each other relatively closely, but lately they have been telling divergent tales. In December, the Department of Labor reported that nonfarm payroll employment rose a soft 199,000. However, the household survey said that roughly 700,000 jobs were created.

“Like last month, today’s jobs report presents a somewhat muddled picture,” says Caldwell. “Ordinarily, we’d place more weight on the nonfarm payroll number, which comes from the establishment survey, which is more reliable.” Caldwell notes that another widely followed jobs indicator, the monthly ADP report, showed gains of 600,000--more in line with the household survey’s strong increase.

Caldwell says the small gains in nonfarm payrolls may not reflect weakness but rather the difficulties facing employers when it comes to hiring. “If the weak growth posted by nonfarm payrolls is correct, then it paints a picture of very tight labor markets,” he says. “I don't think there's any reason to suppose the demand for labor fell in December.”

That labor market strength, Caldwell says, is also showing up in continued upward pressure on wages, as average hourly earnings rose 0.6% in December from the month before. 

“Wage pressures have remained strong in industries seeing the most turnover--namely leisure and hospitality--but are also broadening out."

Within nonfarm payrolls, industries highly affected by the pandemic, such as leisure and hospitality, saw tepid growth in December, Caldwell notes. That’s despite pre-omicron consumer spending. However, “looking ahead to the first quarter of 2022, the spike in coronavirus cases due to omicron is likely to temporarily damp demand for labor.”

The 651,000 gain in the household employment tally was driven by a 482,000 drop in the ranks of the unemployed, coupled with a 200,000 increase in the size of the overall labor force.

While Caldwell says the jobs report keeps the Fed on course for an increase in interest rates in coming months, the central bank has a balancing act to consider. “The challenge for the Federal Reserve will be course-correcting for growing inflation pressures while ensuring that the demand side of the economy is still strong enough to bring employment up to its potential,” he says.