KB Home’s construction of single-family homes is shown under construction in the Valley Center, California community on June 3, 2021.

Mike Blake | Reuters

If the Federal Reserve’s opinion on inflation prevails, there are a few important things that need to be going right, especially when it comes to getting people back to work.

Solving the job puzzle has been the toughest task for policy makers in the era of the coronavirus pandemic, as nearly 10 million potential workers are still considered unemployed despite the number of vacancies available in April according to the latest data from the US – Department of Labor.

There’s a pretty simple inflation dynamic: the longer it takes to get people back to work, the more employers have to pay. These higher salaries, in turn, will trigger higher prices and could lead to longer-term inflationary above-average charges, which the Fed is trying to avoid.

“Unfortunately, we see good reasons to believe that labor force participation will not quickly return to theirs
before Covid, “said Ian Shepherdson, chief economist at Pantheon Macroeconomics, in a statement.” Whatever happens here, the Fed needs a large number of these people to get back into work this fall.

The rate of inflation is critical to economic development. Excessive inflation could force the Fed to tighten monetary policy faster than desired, which could have cascading effects on an economy that is debt-dependent and thus critically tied to low interest rates.

Consumer prices rose at a rate of 5% year-on-year in May, as fast as they have been since the financial crisis. However, economists generally agreed that much of what is driving the rapid surge in inflation is due to temporary factors that will fade as the economy continues to rebound and normalize after the unprecedented pandemic shock.

However, this is far from certain.

The Atlanta Fed’s measure of “sticky” inflation, or prices of goods that tend not to fluctuate much over time, rose 2.7% year-over-year in May, the strongest growth since April 2009. A separate measure for “flexible” CPI, or prices that tend to move frequently, rose an astonishing 12.4%, the fastest since December 1980.

In their latest forecast, Fed officials put core inflation at 2.2% for 2021 as a whole; Shepherdson said the latest numbers suggest something closer to 3.5%.

“This is a huge failure and, with the potential impact on the labor market, it may pose a serious threat to the Fed’s benevolent view of medium-term inflation,” Shepherdson said.

What keeps workers at home

Surveys reveal a variety of factors preventing workers from taking a job: ongoing pandemic worries, childcare issues, especially for women, and expanded unemployment benefits, which are being phased out in about half the states and will expire completely in September.

From an employers perspective, concerns about skill mismatches have existed for several years and have worsened during the pandemic. For example, a survey by the online learning company Coursera showed that the US has fallen to 29th place in the world for the digital skills required for high-demand entry-level jobs.

The dilemma is pervasive in American business these days.

All of my clients are struggling to get staff at a level they need to really get to the other side of this surge.

David Wilkinson

President of NCR Retail

David Wilkinson, president of NCR Retail, the cash register maker that now offers a wide variety of products and services to the industry, said he was seeing “some kind of labor crisis.”

“When labor becomes harder to come by and more expensive, the other side of inflation concerns is that as prices go up, the cost of living goes up and you have to pay people more when they ask for more,” said Wilkinson. “All of my clients are struggling to get the level of staff they need to really get to the other side of this surge.”

While he expects inflation to eventually decline from its current level, it expects it to be above the below 2% that has prevailed for most of the post-financial crisis period.

The implementation of the technology accelerated during the Covid era. While this will continue, Wilkinson also expects retailers to pay higher wages to meet demand for staff.

“We’re seeing an increasing focus on the retail workforce, and that includes the experience, the technology they need to do their job and the willingness to pay,” he said. “That brought that back to the fore.”

It could prove difficult for the Fed to navigate the various dynamics.

Previous attempts to normalize policy over the years have largely failed as the central bank had to return to the interest-free money printing world that emerged during the financial crisis.

“The Fed is trapped,” wrote Joseph LaVorgna, Natixis’ chief economist for America and former chief economist of the National Economic Council.

While LaVorgna thinks inflation is relatively under control, he believes the Fed could run into trouble due to deflationary pressures. The central bank does not like inflation that is too low as it creates a cycle of low expectations that constrains monetary policy during downturns.

“Political pressure to do nothing will be intense,” as national debt rises, LaVorgna said. “If the Fed cannot (or does not want to) eliminate excessive monetary accommodation during a booming economy, how can policymakers do so when growth inevitably slows?”

Markets that bet on the Fed

In fact, the markets don’t expect much movement in politics.

Government bond yields have actually declined since Thursday’s Consumer Price Index report, and market prices are now suggesting that no rate hikes will be made until around September 2022 and the Fed Funds rate will be only 1% until May 2026.

A University of Michigan report on Friday also showed that consumers are lowering their inflation expectations, with the outlook for the coming year at 4%, up from 4.6% in the previous poll and 2.8% over five years, however still at 3%, well above the Fed’s 2% target.

“With all fears that the Fed will be forced to tighten policy prematurely to contain inflation, we suspect officials will be equally concerned about a slowdown in the recovery in real activity,” wrote Michael Pearce, US chief executive -Economist at Capital Economics.

The Federal Reserve Board building is pictured in Washington, USA on March 19, 2019.

Leah Millis | Reuters

Fed officials are likely to talk next week about which direction the risks have tilted in the current scenario. They were lukewarm to the recovery, continued to emphasize the role of the pandemic, albeit shrinking, and encouraging a broad policy response.

However, if inflation data continues to point upwards, pressure will increase to at least curb monthly security purchases.

“There was this debate about whether inflation is any different this time,” said Quincy Krosby, chief markets strategist at Prudential Financial. “When inflation rises more sharply and less temporarily, consumers will need higher wages.”

The Fed is betting that a return to the labor market, especially women, will help keep wage pressures and inflation in check. The current participation rate for women is 56.2%, compared to the lows of the pandemic, but otherwise at the lowest level since May 1987.

Regardless of inflationary pressures, last year the Fed changed its mission statement to keep policy accommodative until the economy sees inclusive job gains, across gender, income and race.

“They’ll make sure the glide path too [policy] The start is long, “said Krosby.” The question is, what does the Fed do when inflation picks up more sensibly and is stickier? That is the concern of the market. “

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