Fed: A tighter labor market will cause 3 interest rate hikes in 2022, economist says

JPMorgan Chief U.S. Economist Mike Feroli joins Yahoo Finance Live to discuss what the Fed's outlook on 2022 should be when taking inflation, interest rate hikes, and overall economic recovery into consideration for their final meeting of the year.

Video transcript

BRIAN SOZZI: The 2022 outlooks from Wall Street continue to roll in. JPMorgan chief US economist Michael Feroli is looking for interest-rate liftoff from the Fed to begin in September and for the unemployment rate to trek lower. Michael joins us now. Michael, good to see you, as always. Thanks for taking the time here. Within your outlook for next year, how many rate hikes are you looking for and why?

MIKE FEROLI: So we actually are now looking for three rate hikes, June, September, and December. We do think the pivot here by not only the chair of the Fed, Powell, but the rest of the committee toward an early tapering or a faster tapering, I should say, is for a reason, and the reason is to get that done with by March so that they can proceed hopefully in a gradual manner to normalize interest rates.

But we do think that's the direction they're going in, and I really think the major reason for expecting that and what's really changed over the last three to six months has been the labor market and just how tight it's become. So we could easily see an unemployment rate below 4% by early next year, and in that kind of environment, having rates near zero just really doesn't make much sense.

JULIE HYMAN: Hey, Mike, it's Julie here. It's really interesting that you focus on the labor-market side of the equation and not the inflation side of the equation, which has been so much more hotly debated, I think. And also hotly debated is the question of whether the Fed has made a mistake here, right, whether it should have started moving already in some way. How are you thinking about that question? Do you think the Fed is behind the ball here?

MIKE FEROLI: So I think they are behind the ball, but that is almost by design, right? So the Fed, I think they provided the economy with a lot of insurance last year in terms of being very accommodative. It turns out a lot of that insurance wasn't necessary so that ex post it appears as though it were a policy mistake, but I think ex ante, given the amount of risks that we were facing around this time last year, it didn't make sense to probably err toward the side of providing more accommodation.

Now, I do think you're right that we are focused more on the labor market, in part because the price-inflation developments we've seen this year, we do-- I mean, I hate to use this word, but we do think they're going to be mostly transitory in that we shouldn't see the really big price increases that we saw in the second and third quarter going into next year. But when you think in terms of really persistent inflation developments of the type we saw in the '60s and '70s, that has to occur-- or that always occurs with a sort of a wage-price spiral. And so without wages following suit of higher prices, we don't think this would actually have any legs. But because we do think wage inflation is picking up, that's a reason that this inflation that we've seen this year has the risk of becoming more persistent if the Fed were not to act.

JULIE HYMAN: And for lack of a better word, is it the Fed's fault that we have seen inflation pick up as it has-- leaving aside the wage question for just a moment, what we've seen already this year?

MIKE FEROLI: I think that would be-- I'm not sure I would agree with that. Had the Fed hiked earlier this year, it's not clear that they would have slowed-- that that would have changed much the type of nominal demand growth we saw occur. I think a lot of that was because of the reopening of the economy and the amount of fiscal stimulus provided.

So I think, you know, had the Fed acted differently this year, you might have only seen moderately lower inflation, but you would have, I think, risked perhaps worse outcomes in terms of the labor markets. So I do think, you know, as I say, they are a little behind the curve, but, you know, they can catch up to the curve. I'm quite sure of that.

BRIAN SOZZI: Michael, where do you see the unemployment rate going next year?

MIKE FEROLI: I think by the end of the year we could be in the low 3s, below 3 and 1/2%. We have-- that has been really quite stunning how much the unemployment rate has fallen. It's down 1.7 percentage points over the last five months.

We do expect that pace of decline to slow, but still doesn't take much when you're at 4.2% to get below 4% or even 3 and 1/2%. So we do think we could end the year around 3.4% even with a little bit of a tick up in the labor force participation rate, which has been depressed over the last year and a half.

JULIE HYMAN: So, Mike, the picture that you're painting here of this low unemployment rate, of wages starting to go up more, are we expecting to see-- are you expecting to see other types of prices-- price gains moderate? And if so, isn't that a pretty robust picture for the economy? In other words, if inflation is coming because people are making more money and things aren't going up at the same rate, like, people would seem to have a good amount of spending power, right?

MIKE FEROLI: Yeah, I think it is. Look, I think the overall picture for next year is favorable.

Now, the inflation we saw in the second and third quarter of this year was really concentrated in consumer goods and particularly a few categories like autos and a few other things, which seem to be related, in part, to these bottlenecks that everyone has been talking about. And that we do expect to come off, and we're already seeing some evidence that auto production is picking up, some of the supply-- some of the chip shortages gradually easing. So I do think it's reasonable to expect some of those goods prices-- goods price inflation to moderate.

But we do think underlying trends in inflation, things like services and rent certainly, will be moving higher but probably not at the same pace that wages are growing. So I do think it's a pretty favorable picture when you think about real wages or overall real disposable spending power, which, you know, is kind of the flip side of this year. This year, generally speaking, wages didn't keep up with price gains, and next year we expect a little bit of a payback, if you will, with wages growing faster than prices.

BRIAN SOZZI: Michael, we've seen a lot of very large companies start to push back their return-to-office dates for next year because of the pandemic. Have you built that risk in? Is it a risk to your economic outlook?

MIKE FEROLI: It is, and I do think we should-- we are expecting certainly to see some slowing, notable slowing in the first quarter because of the seasonality of the virus waves, which seems to be, I think, pretty well accepted by now. So we do think that could weigh a little bit on consumer spending in December, January, and we actually-- we're already starting to see a little bit of that, I think, in some of our Chase card data.

So I do think it's reasonable to expect that, in what is otherwise a very favorable picture for the economy, we are going to have a little bit of a bump in the road here, I think, in the winter months due to the rising case counts that we've been seeing. We would expect that to continue after the Christmas holiday as well. So I do think that maybe it's a little bit of a blemish on what is otherwise a pretty favorable backdrop for the economy.

BRIAN SOZZI: All right, really enjoyed your work here. Michael Feroli, JPMorgan chief US economist, good to see you. Have a great rest of the week.