Growth in the U.S. labor market shattered expectations in January, confounding analysts and economic models as the worst bout of inflation in 40 years shows signs of easing.
For the month, the United States added 517,000 jobs, the Labor Department reported Friday, nearly double the prior month's advance and smashing an estimate of 188,000 in a Bloomberg survey of economists. The U.S. unemployment rate dropped 0.1% to 3.4% in January, a low not seen since May 1969, according to the agency.
Wall Street's big rally to start 2023 hit a wall Friday after the report. The S&P 500 fell 1% for its first drop in four days. The Dow Jones Industrial Average dropped 0.4%, while the Nasdaq composite sank 1.6%.
U.S. job gains had been steadily dropping for months, but January's stunning growth and lower jobless rate amid now-cooling inflation reflects unexpected tightness in the labor market.
"Today's jobs report is almost too good to be true," said Julia Pollak, chief economist at ZipRecruiter. "Like $20 bills on the sidewalk and free lunches, falling inflation paired with falling unemployment is the stuff of economics fiction."
The Federal Reserve launched its campaign in March to knock down inflation, hoping policymakers could hoist interest rates without slowing the economy so much as to undercut strength in the labor market.
Myriad price gauges tracked by the Fed have shown inflation cooling in recent months -- although remaining above the Fed's 2% target -- with the expectation that hiring would follow suit.
Fed officials have been watching the robust U.S. job gains out of concern that employers, desperate to hire, would keep boosting pay and, in turn, keep pushing inflation higher.
At a news conference Thursday, Fed Chair Jerome Powell argued that much of the easing in inflation has reflected falling prices for goods -- items such as used cars, furniture and shoes -- as well as sharply lower gas prices.
Those price declines reflect a clearing of formerly clogged supply chains, he suggested, and will likely prove temporary.
But Powell reiterated one of his central concerns: Inflation in the labor-intensive services sector is still rising at a steady 4% pace and shows no sign of slowing.
Much of that increase is a consequence of strong wage growth at restaurants, hotels and transportation and warehousing companies, with fewer workers available to take such jobs. Average hourly earnings for workers overall were 4.4% higher in January than a year earlier, a slowdown from December's 4.8% increase, according to the Labor Department.
"My own view," Powell said, "would be that you're not going to have a sustainable return to 2% inflation in that sector without a better balance in the labor market."
Overall, job gains last month were spread across a wide range of industries, according to the data Friday. The largest increases were in leisure and hospitality, professional and business services, and health care. More than 128,000 jobs were added in leisure and hospitality alone in January, with the largest gains in bars and restaurants.
Still, employment in the booming sector remains about 500,000 jobs below its pre-pandemic level. Employment in professional and business services rose by 82,000, while employment in health care rose by 58,000 jobs, according to the Labor Department.
Economists are scratching their heads as to whether the U.S. labor market is truly as strong as the January report indicated or if wonky adjustments are getting in the way.
The January employment report was complicated by the U.S. government's annual benchmarking process, as well as an update of seasonal-adjustment factors and population controls that economists had indicated could make the data difficult to interpret.
The jobs report is made up of two surveys, one of households and the other of businesses. Each were affected by the Labor Department's yearly fine-tuning process, designed to paint a more accurate picture of the job market.
The release included an annual update to the population controls used in the households survey, which tracks the unemployment and participation rates, as well as the employment-to-population ratio. The adjustment boosted the estimated population size by nearly 1 million and the civilian labor force by 871,000.
For the businesses survey, the federal government's updated seasonal factors may have impacted the headline payrolls figure. Overall, on an unadjusted basis, payrolls actually fell by 2.5 million last month, according to the data.
The Labor Department also reclassified about 10% of employment into different industries in accordance with an update to the North American Industry Classification System.
That resulted in "major revisions" to sectors such as retail trade and information, as well as "minor" ones within industries such as manufacturing and financial services, according to the report.
What's more, the yearly update to the establishment survey showed job growth was revised higher for the final six months of 2022.
But others aren't so convinced that the revisions played much of a role. The 2.5 million decline in unadjusted payrolls was the smallest for January since 1995 -- significant for a month that's typically weak from laying off holiday workers.
"We can't completely dismiss all of these data. We can't blame it on the seasonals," said Jennifer Lee, senior economist at BMO Capital Markets. "Breaking it down by industry, it's pretty safe to say there's wall-to-wall strength."
In economic models used by the Fed and most mainstream economists, a job market with strong hiring and a low unemployment rate typically fuels higher inflation.
Under this scenario, companies feel compelled to keep boosting wages to attract and keep workers. They often then pass those higher labor costs on to their customers by raising prices. Their higher-paid workers also have more money to spend.
Both trends can feed inflation pressures.
Yet even as hiring has been solid in the past six months, year-over-year consumer inflation has slowed from a peak of 9.1% in June to 6.5% in December, according to the Labor Department's Consumer Price Index.
Much of that decline reflects cheaper gas. But even excluding volatile food and energy costs, the Fed's preferred inflation gauge -- one separate from the CPI -- rose 4.4% annually in December, not so far above its 2% target.
The trends of slowing inflation have raised questions about a core aspect of the Fed's higher rate policy. Powell has said that conquering inflation would require "some pain." And Fed policymakers have forecast the unemployment rate to rise to 4.6% by the end of the year. In the past, an increase that large in the jobless rate has occurred only during recessions.
Yet Friday's report suggests the possibility that the long-standing connection between a vigorous job market and high inflation has broken down.
And that breakdown holds out a tantalizing possibility: That inflation could continue to decline even while employers keep adding jobs.
"Their model is that this inflation is driven specifically by wage inflation," said Preston Mui, senior economist at Employ America, an advocacy group. "In order to get that down, they think we have to bring some pain in the labor market in terms of higher unemployment. And what the past three months have shown us is that that model is just wrong."
That said, it's possible that Friday's report could still nudge the Fed in the opposite direction: The consistently strong job growth might convince Powell and other officials that, despite signs that wage growth is slowing, a powerful job market will inevitably reignite inflation.
If so, their benchmark rate would have to stay high to cool the pace of hiring.
With that outlook in mind, Wall Street traders are now pricing in an additional Fed rate increase this year: Investors foresee a 52% likelihood the Fed will raise its benchmark rate by a quarter-point in both March and May, to a range of 5% to 5.25%.
That's now the same level that Fed officials had predicted in December.
Many economists say the pandemic so disrupted the job market that it is acting differently than it has in the past.
"There are a lot of norms .... that aren't normal anymore," Labor Secretary Marty Walsh said Friday. "We're seeing a lot of companies maybe not doing layoffs in January that they normally would have because they went through a pandemic where they lost people and they didn't come back."
Information for this report was contributed by Lauren Kaori Gurley and Rachel Siegel of The Washington Post; Christopher Rugaber and Paul Wiseman of The Associated Press; and Molly Smith and Steve Matthews of Bloomberg News (WPNS).