Federal Reserve Chairman Jerome Powell said this week that interest rate increases could be higher and come faster if Friday’s unemployment data shows the nation’s labor market isn’t cooling off.

Stock indexes fell after his comments. That’s been a familiar pattern over the past year as the federal bank has tried to combat inflation. 

A hot jobs market — when people who want work can find it — would seem to signal a healthy economy, so why the concern over a positive jobs report?

It’s not that the Fed is “anti-worker,” said Joseph Gagnon, senior fellow at the Peterson Institute for International Economics and former visiting associate director for the division of monetary affairs for the Federal Reserve Board. 

“If we could sustain 3% or 3.5% unemployment, a record low, the Fed would be delighted if we could stay there and inflation would come back down and everything would be fine,” he said. “ … The worry is that the economy is just overheating, that too much spending is going on for what the economy can produce. And we see that in the labor market. It’s not only the labor market that the Fed looks at, but it’s the labor market that probably has the clearest signs of it, the ones that are easiest to interpret. … It covers every worker who’s doing anything economic, who is producing anything in the whole economy.”

Federal Reserve members also will be looking at consumer price data, due on March 14, at their next meeting on March 21-22. The Consumer Price Index, an indicator for inflation, rose 6.4% in the past year, according to the January report, which was the smallest yearly increase since Oct. 21, but still higher than a Bloomberg survey of economists forecasted, according to The New York Times. That followed the January jobs report, on Feb. 3, which showed an unemployment rate of 3.4% — the lowest it had ever been since May 1969.

Andrew Korz, director of investment research for FS Investments, predicted the data was “running too hot for the Fed’s liking,” and Powell’s comments this week indicate Korz was correct.

“The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,” Powell told the Senate Banking Committee on Tuesday. “If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”

The Fed’s target rate for inflation is 2%, and the Fed has repeatedly said that it won’t stop raising rates until it meets its goals. 

“The Fed has really two things that it is trying to control and sometimes they can work against each other or in opposing directions,” said Lara Rhame, chief U.S. economist and managing director for investment research for FS Investments. “One of them being inflation and keeping inflation low and the other one being, they call it full employment but you know a healthy level of employment and right now they see both of these objectives and they’re weighing which one is more important to tackle and which one is further off course, and by far and away, inflation has been over the last year and a half, very far away from their targets — way too high.”

The stock market has responded strongly to the labor market data in part because of the importance of those numbers to the Fed when it makes decisions about interest rates. After the January jobs report showed that the labor market was continuing to add more jobs than economists previously expected and that unemployment remained low, the Dow Jones Industrial Average fell 0.38%, the S&P 500 dropped 1.04%, and the Nasdaq Composite slumped 1.59%.

The stock market responded positively to a December jobs report with a low unemployment rate of 3.46% that also showed slower wage growth than what economists anticipated. 

How the market reacts to the jobs report largely depends on what it thinks the news of the report is, said Gagnon of the Peterson Institute.

“If the jobs report comes in very strong, sometimes the stock market doesn’t like it because it worries that the Fed is going to have to tighten,” he said. “ … If everybody knows the economy is strong but they think the Fed doesn’t know it and then the jobs report is news to the Fed, and the Fed is going to have to tighten, that makes sense. On the other hand, if  nobody knew the economy was strong and the job market report tells you that it’s strong and that was news to you, that should be good for stock prices because it means there’s more sales and activity and profits.”

People are right to be concerned about the potential impact on the economy if the Fed continues to raise rates, Gagnon continued. Although the Fed has said it hopes for a “soft landing” for the economy as it continues to raise rates, it has sparked fears of a possible recession. 

“If you just look at history, it doesn’t make you very optimistic,” he said. “The Fed has rarely caused a soft landing and held inflation in check, let alone pushed it back down without a recession. … To some extent, the Fed made mistakes in the past, and they might have raised rates too much, right? But also to some extent they made opposite mistakes, and they raised rates and they didn’t get inflation all the way back, and so it ratcheted up each cycle and it went higher.”

Gagnon said that he thinks there is a 30% to 35% chance of a recession as a result of the Fed raising rates too much.

Rhame, with FS Investments, said it’s important to keep in mind that despite layoffs at some large companies, the overall trend is that companies are still talking about trying to find workers and needing to pay them more to hire them. 

“We had several negative quarters of growth at the beginning of 2022 and a lot of people wondered why we weren’t calling that a recession,” she said. “And it’s because we didn’t have job losses during that period. In fact we were adding millions of jobs over those quarters because we were still in that recovery phase of the pandemic and still getting folks back to work. I often talk to people who say job losses cause a recession. Job losses are the recession. … So folks should look out for job losses, which we have not seen yet.”