Weak Payrolls and Surging Oil Prices: Which Way Should the Fed’s Policy Balance Tilt?

TradingKey - The Federal Reserve is caught in the crosshairs of a policy dilemma: on one side is the real pressure of a cooling labor market, and on the other is the inflationary threat buried by soaring energy prices. Whether to keep tightening the high-interest rate reins to suppress prices or to loosen up early with rate cuts to support employment has become a difficult problem for policymakers.

The dual shock of healthcare worker strikes combined with an extreme cold wave caused U.S. non-farm payrolls to shrink unexpectedly in February, with a net loss of jobs and a slight uptick in the unemployment rate. At the same time, the ripple effects of the Middle East conflict pushing up oil prices ( USOIL) have placed new shackles on the Fed's policy space. Although overall market expectations for rate cuts have not fluctuated significantly, the dilemma facing policymakers is becoming increasingly clear.

Non-Farm Payrolls Disappoint

The non-farm payroll report released Friday by the Bureau of Labor Statistics (BLS) of the U.S. Department of Labor delivered a "sharp turn" to market expectations—non-farm payrolls unexpectedly decreased by 92,000 in February, far below the market expectation of a 59,000 increase. Meanwhile, the job gains for January were revised down to 126,000, signaling that signs of a cooling labor market are already quite evident.

The weakness in employment data is also reflected across multiple dimensions: the labor participation rate fell to 62.0%, the lowest level since December 2021. The household survey showed a decrease of 185,000 employed individuals, directly pushing the unemployment rate from 4.3% in January to 4.4%.

Market analysts believe the unexpected decline in February employment data is the result of combined short-term shocks and long-term trends. The healthcare industry cut 37,000 positions in a single month due to physician clinic strikes, with the strikes directly causing 28,000 job losses. Simultaneously, severe weather during the month hit offline service employment. The significant growth in January was largely due to statistical adjustments from the Labor Department's corporate model updates; the February data serves as a natural correction to this "inflated growth," reflecting that the real growth rate of the job market has actually been slowing for some time.

Data released this week by employment consultancy Challenger, Gray & Christmas corroborated this from another perspective. U.S. companies announced 48,307 layoffs in February, down 55% from January and 72% from the same period last year, but corporate hiring plans also dropped 63% year-over-year. Fewer layoffs do not mean the labor market is warming up; rather, it may mean companies are controlling costs through "hiring freezes" instead of "mass layoffs." This "hidden employment weakness" could lead to some unemployed individuals falling into long-term unemployment traps.

International Oil Prices Soar

Military actions by the U.S. and Israel against Iran are dragging global energy markets into a new round of volatility. International oil prices surged from approximately $72 per barrel before the conflict to over $110 per barrel. Passing through to the consumer end, U.S. gasoline prices are also skyrocketing.

The U.S. inflation rate has been above the Federal Reserve's 2% policy target for five consecutive years, and this energy supply shock undoubtedly adds insult to injury.

Fed Governor Waller stated: "Gasoline prices are going to surge. Americans will see this at the pump; they’ll be goggle-eyed and a bit shocked. But if this fades in a matter of weeks or even two months, then it doesn't pose a significant impact in the long run."

For a long time, the Fed has viewed energy shocks as negligible short-term disturbances, preferring to wait and see rather than proactively respond to price fluctuations. However, since 2020, the Fed has encountered several rounds of supply shocks: the pandemic, the Russia-Ukraine conflict, government tariff policy adjustments, and now the hostilities in Iran. These cumulative uncertainties are continuously narrowing the Fed's room for policy adjustment.

Minneapolis Fed President Neel Kashkari said the current situation could repeat the shadows of the Russia-Ukraine conflict. He specifically mentioned the Fed's embarrassing misjudgment in 2021—when the Fed dismissed surging inflation as transitory—and now he poses a soul-searching question: If this ultimately evolves into a global commodity shock, are we going to have "Transitory Inflation 2.0"?

The Fed is caught in an unprecedented dilemma. Ellen Zentner, Chief Economic Strategist at Morgan Stanley Wealth Management, said bluntly that today's data puts the Fed between a rock and a hard place. While a significantly weakening labor market could support rate cuts, the Fed may have to stand pat given the risk that long-term high oil prices could trigger a new round of surging inflation.

Olu Sonola, Head of U.S. Economic Research at Fitch Ratings, wrote: "It's bad news no matter how you look at it. Combined with the resurgence of tariff disputes, higher energy prices, and new inflationary pressures, the Fed is basically like a 'deer in the headlights' until these data points form a sustainable, actionable trend."

Clash of Hawkish and Dovish Views

Judgments within the Fed regarding the current economic situation are showing clear divergence, with the clash between hawks and doves becoming increasingly prominent.

Chicago Fed President Austan Goolsbee stated that as conditions improve, inflation will make progress, and a rate-cutting process could be initiated by the end of this year to return interest rates to a stable range below current levels.

However, he also admitted that as uncertainty factors like geopolitical conflicts increase, the reasonable timing for action is being delayed, and the window for policy adjustment is being gradually compressed.

Governor Miran, on the other hand, believes that rising oil prices will directly squeeze economic demand because people need to spend more on energy products, which in turn weakens overall economic vitality.

Therefore, while he remains in a wait-and-see mode regarding oil price fluctuations until more information is available, if the impact of rising energy prices continues to manifest, he would be more inclined toward a more dovish policy, stimulating the economy through rate cuts.

In contrast is the tough stance of hawkish officials. Cleveland Fed President Beth Hammack emphasized that policy should remain on hold for a considerable period until there is clear evidence of inflation cooling and further labor market stabilization, to avoid a rebound in inflation caused by premature easing. Boston Fed President Susan Collins echoed this view, calling for a "patient and prudent approach" to interest rate policy without being distracted by short-term data fluctuations.

Wall Street Journal senior reporter Timiraos analyzed that Fed officials will currently remain primarily in wait-and-see mode. Although Fed Chair Jerome Powell pushed colleagues to complete three rate cuts late last year, the controversy over rate-cut decisions among the 12 voting members at each FOMC meeting is escalating.

Officials have made it clear that they will not rush to change the direction of interest rates at the meeting later this month; no matter how worrying a single month's data may be, it is unlikely to alter this stance.

However, Timiraos also pointed out that if the unemployment rate continues to climb in the coming months, the Fed could indeed start cutting rates mid-year. But this decision will inevitably meet opposition from some officials, because before the Iranian conflict brought new pressure to energy prices, the momentum for U.S. inflation to fall had actually already stalled.