Fed’s Mester: Expect ‘more strength’ in the labor market this year

Cleveland Fed President Loretta Mester sat down with Yahoo Finance’s Brian Cheung to discuss April’s disappointing jobs report, inflation concerns and the outlook for the U.S. labor market.

Video transcript

JULIE HYMAN: Brian Cheung joins us now with a regional Fed president. Brian.

BRIAN CHEUNG: Thanks, Julie. Well joining us now here on Yahoo Finance for an exclusive interview is Federal Reserve Bank of Cleveland President, Loretta Mester. Thank you so much for joining us here on the program this morning. I want to kick things off with what everyone's been talking about. That is the jobs report from last Friday showing 266,000 payroll ads for the month of April. A lot of people on the street were expecting something closer to a million. So just wondering how you're thinking about that report and what may have explain that weaker than expected number.

LORETTA MESTER: It was a disappointing report, but I don't think it changes my outlook. I think the outlook is still bright. And maybe the surprise should have been the March report, because it was so strong. So you don't read too much into one report whether it's a very positive report or a disappointing report. I think what it does show, is that something that we've heard from a lot of our contacts, which is that it is, labor supply is not plentiful.

A lot of the firms are saying they'd like to hire, but they're having some issues finding workers. And that could be what was reflected in the report. The labor supply of women in particular was down. So again, I think we have to look through it. The economy is adding jobs, and that's a good thing. But it's a reminder that we can shut down the economy quickly, which we did last year. When we reopen, we're reopening, it varies across sector.

There's still school issues. Schools aren't reopened, and that affects labor supply. People haven't been fully vaccinated yet, although we're making great progress. So there may be concerns about, health concerns about reengaging. And the support that families have give them the opportunity to stay out of the workforce until they feel more comfortable re-engaging. So I think all those things affect supply, and that's what we saw in that report. But bottom line, we're still adding jobs. And I think the outlook is bright.

BRIAN CHEUNG: So President Mester, I want to back up. If you said that maybe it was the March report that had about a million job gains, it was revised down after the fact was the real surprise, does that change the outlook that or the guidance that we had gotten from the Fed chairman, who had mentioned that you might want to see a string of jobs reports of one million payroll adds a month to get to substantial for the progress. So does the April report then change that measuring stick?

LORETTA MESTER: No, I think that's a good way of thinking about it. Like we never take one report as being reported. I mean, we get volatility in these kind of monthly numbers all the time. And of course, coming out of the pandemic, we should expect to see even more issues with measurement and how to interpret the numbers. We've never come out of a pandemic like this and a shutdown of the economy.

So I think what we want to see, and I certainly want to see, is more progress and broader progress. Right now, we're in a recovery, no doubt. And the strength that we came out of this is actually quite a good sign. But I think we're going to see some ups and downs as we open up more. There are some parts of the economy that are still very weak, even though they're making progress, like leisure and hospitality.

There are other parts in the economy that are back up to levels we saw pre pandemic, for example, housing is strong, manufacturing is almost back up to pre pandemic levels. And so we have this mix of things that differ across sectors. And I certainly am looking to try to see that the recovery broadens as it continues. I expect that to happen. And so I want to see more strength in the labor market as we go forward, and I'm expecting that this year.

BRIAN CHEUNG: So we had a conversation with the San Francisco Fed President, Mary Daly, just yesterday. She was saying she doesn't like the terminology of calling the dynamics in the labor market, a labor shortage. There's a lot of weird dynamics at play. But there's a hot debate about the impact of unemployment insurance, the extra benefits that were provided through the stimulus. At least what you're seeing in your district, which is centered around Cleveland, Ohio, is UI indeed a major factor in holding people back? Or is it some of the other things that you had mentioned earlier?

LORETTA MESTER: Yeah, I mean, there's a lot of things at play there. Certainly the businesses will attribute it to that. But frankly, I think it's more the fact that we still, I think overall in the country, we're over 100 million people have gotten vaccinated, but that's still in play, right, we're still, vaccination penetration is still going up and that needs to continue. So I think there's still some fears to go back in because of health concerns.

I think it's a serious issue about child care, home schooling. We saw that early in the pandemic where women withdrew strongly from the workforce more so than men. And I think that's still we haven't really reopened schools totally. They're not back to where they were. And I think those issues are significant. It is true that with the extension of the unemployment benefits, people are in a financial position so that they can make those hard choices about whether they feel comfortable re-entering or not.

So in that sense, it gives support to families. But I don't think that's the main issue. I think these other issues are playing a larger role, and it's just going to take time for those to work themselves through. So I think that's what we're seeing certainly in my district. I think there are these significant issues. And businesses will say that even keeping staffing, people on their payroll on the payroll, there's volatility in any day, right. Because people might have to stay home because schools have been closed back down because of a quarantining or even quarantining because someone has been exposed within the factory.

So I think those issues are what we're seeing. And until we get a broader vaccination rate, and I expect that to continue throughout the third quarter of the year, until we get really those high, high levels of vaccinations, we're going to see that kind of, we can restart things, but we're going to still have these issues that are affecting, are we back to normal yet. And I think that's just going to take some time to get to.

BRIAN CHEUNG: So I want to ask about the inflation side. Obviously, price stability, the Fed's other dual mandate, seems like tech stocks. You don't want to attribute to one thing, but are pretty sensitive to these concerns about rising inflation. Actually there's a Bank of America note that mentioned inflation, mentions in quarterly earnings calls and reports have been up 800% year over year. So what is your forecast from where inflation is going to go? How is that factoring into also your reaction function on maybe tapering and or raising rates at some point?

LORETTA MESTER: Right. So that's a good question, Brian. So just as supply and demand are being seen in the labor market, we have an increased demand for labor and we have some supply issues, I think we're saying exactly the same thing in product markets. And that's one of the things, supply chain issues are affecting certain products, commodities, very much so in terms of their pricing. We hear that across the firms, across various different sectors in our district that firms are facing these higher costs for components and for commodities.

The other thing that's happening with the inflation measures, is that the very low readings of inflation from last year when the economy shut down are going to fall out of those year over year numbers. So I expect to see inflation readings for the next couple of months be elevated, just with a simple mathematical reason that those low numbers are going to fall out. And then on top of that, the supply constraints are going to put some upward pressure, especially on inflation readings from the PPI. How much that'll feed through into the broader consumer price numbers, we'll see.

My expectation is that we'll end the year with inflation above 2%. But that next year, as those supply constraints are eased, inflation numbers will go back down. And then with the support of monetary policy and fiscal policy, we'll see those inflation readings move back up. So temporarily high inflation readings, right, and then moving back down. That's my baseline forecast. But there are upside risks to that forecast. And that's where we're very focused, and I particularly am very focused on readings on inflation expectations. People, their expectations are really tied to some of the prices they experience.

BRIAN CHEUNG: Right.

LORETTA MESTER: And so I'm looking at survey measures. I'm going to be looking at the market-based measures to see whether inflation expectations are rising, at what pace they're rising. We're aiming to have inflation move above 2% because inflation was so long for so, so low for so long. So seeing inflation move up to 2% and somewhat above 2%, is not a problem. We want to have inflation expectations anchored at levels that we can make that average inflation be 2% over time.

BRIAN CHEUNG: Right.

LORETTA MESTER: That in itself isn't bad. It's just, are we, where is the inflation numbers? And that's where I'm going to be focused. I'm going to be looking at that and looking at where inflation is going.

BRIAN CHEUNG: Now the other part of this is also financial stability risk, right? One caveat to the Fed providing this easy policy is that they'll continue to do so unless maybe there's something bubbling up in the system. So there was a Fed report last week that flagged maybe hedge funds as a blind spot. What are you seeing largely right now? Do asset valuations worry you, or is Fed policy really in the right place and there's no concerns about that happening right now?

LORETTA MESTER: Yeah, I mean, so my read is that there are certainly in terms of equity prices, there's upward, they're high. There's upward valuation pressure there. I think the financial stability risk overall, I would view as moderate. However, I think we have to recognize that there are parts of the financial system that we have less insight into. And my expectation is we'll see some volatility in markets. That in and of itself, isn't a problem. It's when that volatility is coupled with high degrees of leverage where you might have a financial stability risk.

So I'm certainly attuned to that. And I think given that our expectation is that the economy is going to require high levels of accommodative monetary policy, we should be very attuned to what what's going on in those markets. I don't see it as an elevated risk at the moment, but it's certainly something we have to be attuned to. And that's why I think the best strategy is to focus on resiliency. We want our markets and our financial institutions to be resilient to any kinds of shocks that might hit them.

And I think after the last financial crisis, there was a lot of focus on raising the resiliency of the banking system. And of course, the financial crisis was centered on the banking system, commercial banking system. That served us very well coming into this pandemic crisis, because the banking system was able to play an important role to help get credit to households and businesses.

I think once we get out into better times and we get beyond the pandemic, we need to focus on other parts of the financial system, make sure they're resilient as well. But that's a future endeavor. I think right now we have to focus on making sure that our monetary policy is well calibrated to where the economy is going in terms of progress on our dual mandate goals. And I think that's what we're focusing on. That's certainly what I'm focused on at the moment.

BRIAN CHEUNG: So that's forward looking, I want to look backwards really quickly and just zoom out. The Fed made a pretty big change to its framework and I want to rewind to February 2020 where you, in addition to other Fed members, were kind of pondering if the Fed had gotten the economy to pretty much full employment. Now we're looking back now with this new framework and saying, maybe there was more room to go even pre pandemic to pulling in marginalized workers back into the economy. So with the framework aside, how have you think your personal views have changed in regards to the Fed's reaction function and what you need to see in order to tighten?

LORETTA MESTER: Yeah, I mean, that's a really good question, Brian. And I've been thinking about sort of our forward guidance is, we give two forward guidance. One on the interest rate, one on asset purchases. And of course, substantial further progress on asset purchases. And one way to think about that is, are we back to this relatively generally strong conditions we had in the employment and the labor markets back in February. And we're not there yet. So that's one way to benchmark it. But there's many different indicators to use. And I like to look at various indicators to see where we are.

I think one of the things I learned was that these underlying changes in the structure of the economy really give us more, I mean, one reason we changed the framework, I know you don't want to go back to the framework, but there was a real reason to change the framework, and that was because of these underlying structural changes in the economy. One, that the general interest rate, sustainable interest rate is lower than it was decades ago. That's one big change.

The other one, of course, is that the relationship between or the correlation between slack in the economy, labor market, product market slack and inflation is much less than it was in the past. And that inflation expectations really drive inflation, actual inflation. And so those changes led to the change in the framework, which generally, I would say means that for the same economic conditions, we're going to be running generally a slightly more accommodative monetary policy.

But that doesn't mean it's any riskier. It means that the economy has changed. And so a more [? economy ?] policy is what's required to make our goals of maximum employment and price stability. So I don't view it as being we're taking on more risk. I view it as being, using the strategy that will achieve our goals more effectively in the new economic environment we're operating in.

BRIAN CHEUNG: All right, well, definitely something to keep watching. We actually went over our time. Some of these topics can get so interesting. But again, Cleveland Fed President, Loretta Mester, thank you so much for stopping by here on Yahoo Finance this morning.

LORETTA MESTER: Thanks.

BRIAN CHEUNG: We'll toss it back over to Julie.