The Fed thinks the strong labor market is finally losing steam, but recent data on jobless claims and nonfarm payrolls seems to contradict that claim.

The Fed’s Beige Book, which summarizes economic conditions across the country, said “labor market tightness continued to ease across the nation” in October and that “several districts reported improvements in hiring and retention as candidate pools have expanded.”

In other words, the central bank thinks competition for labor is decreasing as more workers become available. That, in theory, should slow wage growth and inflation.

Yet, the latest report on nonfarm payrolls showed employers added a whopping 336,000 workers last month—double what economists had expected.

Meanwhile, jobless claims for the week ending Oct. 14 fell to 200,000, the lowest since January. While jobless claims rebounded to 210,000 last week, they remain at the lower end of the yearly range and well below the peak of 265,000.

Mixed signals from the labor market make it difficult to predict the Fed’s next move at a time when investors, consumers, and businesses seek more clarity on the direction of interest rates.

Understanding the Fed’s strategy

A strong labor market is one of the biggest contributors to soaring inflation. According to central bankers, competition for workers is putting upward pressure on wages and making it harder to contain inflation.

To that end, the Fed has raised interest rates 11 times since March 2022. It’s succeeded in bringing inflation down from peak levels, but it's still nowhere near the Fed’s target of 2%.

In September, the consumer price index rose 3.7% on a 12-month basis.

Even worse, economists think that bringing inflation down from 9% to 4% was the easy part. According to them, the real challenge will be trimming those last few percentage points.

“The Fed has got lucky so far in what it’s gotten,” said Steven Blitz, chief U.S. economist at GlobalData TS Lombard. “Most of the decline in inflation was going to happen anyway. They really own the part that’s to come.”

That's the reason many are also urging the Fed to jack up the inflation target and hold off on further rate hikes.

So far, the Fed has resisted the idea. "We think it's really important that we do stick to a 2% inflation target and not consider changing it," Fed chair Jerome Powell said in his testimony to the Senate this past March.

Mixed signals

Expectations are high that the Fed will keep interest rates on hold until the start of 2024, but beyond that, it’s anybody’s guess.

The main reason that a rate hike isn’t imminent is because the Fed is content letting the markets do its heavy lifting. Treasury yields have soared in recent months, pushing up the costs of consumer loans and mortgages.

“We have to let this play out and watch it, but for now, it is clearly a tightening in financial conditions,” Fed chair Jerome Powell said in a conference earlier this month.

“Powell is not going to signal a hard stop to rate hikes,” Tim Duy, chief economist at SGH Macro Advisors, told The Wall Street Journal. “He’s always going to dangle the possibility of another hike. But the data needs to change markedly to push the Fed in that direction.”