Jobs report, bank failure complicates outlook on interest rates

Investors in interest rate futures markets saw a nearly 60% chance of a rate hike of a quarter point, or 25 basis points, on Friday afternoon, CME Group said. The probability of a larger 50 basis point increase fell from 70% on Thursday to 40%.

Employers added 311,000 jobs in February and revisions from previous months were minor, meaning that jobs have averaged more than 350,000 jobs per month since December – robust growth in an already tight labor market. The unemployment rate rose to 3.6% last month as more people looked for work, a further sign of economic strength.

But wage growth slowed last month, suggesting strong labor demand is not leading to rapid increases in workers’ wages. Average hourly wages for private sector workers rose 4.6% over the 12 months through February, but the pace slowed to 3.6% year-on-year over the past three months.

For policymakers, “if you’re wavering between 25 and 50, you’d be more likely to go 25 right now because of the added concern” about Silicon Valley Bank’s bankruptcy, said Eric Rosengren, who was president of the 2007 Boston Fed until 2021.

Friday’s employment report shows the labor market is too hot, said Mr. Rosengren. But the problems at Silicon Valley Bank illustrate how quickly raising rates gives the Fed less time to monitor the delayed impact of its actions, he said.

“It should be a matter of concern that a bank worth nearly $200 billion has a liquidity problem that caused bankruptcy in the middle of the week,” said Mr. Rosengren. Fed officials will “want to be able to evaluate what impact it will have on broader financial markets.”

The Fed’s policymakers were scheduled to begin their traditional pre-meeting quiet period on Saturday ahead of their March 21-22 meeting.

Fed Chair Jerome Powell said this week that the central bank is keeping its options open to consider raising its benchmark federal funds rate by a quarter point — as officials did last month and was widely expected until recently — or by a larger half point, as they did in December.

“I emphasize that no decision has been made on this matter yet,” said Mr. Powell Wednesday. “But if the totality of the data indicated that faster tightening is warranted, we would be willing to step up the pace of rate hikes.”

In addition to Friday’s employment report, he said two inflation reports next week, including the consumer price index expected Tuesday, could influence the decision.

Economists from Bank of America and Morgan Stanley said on Friday they thought the quarter-point smaller interest rate hike was more likely, but that was based on their expectation that core CPI prices, excluding food and energy, would rise 0.4% in February. will rise.

“With no surprise on Tuesday, we think they’ll be comfortable” with a quarter-point rate hike, said Vincent Reinhart, chief economist at Dreyfus and Mellon and a former senior Fed economist.

Others think the inflation report will have to be dovish to prevent the Fed from raising rates by half a point. Aside from a major inflation surprise, signs of broad-based strength in the labor market strongly suggest that the Federal Reserve will need to raise its policy rate by 50 basis points this month, said Joseph Brusuelas, chief economist at consulting firm RSM US.

He said hardships from interest rate risk “at select small and medium-sized banks are not enough to pull the Fed back from its primary objective” of fighting inflation.

If the CPI doesn’t slow noticeably in February, “it will have been very difficult to open the door to 50 and not walk through that door,” said Jason Furman, a Harvard economist who was a top adviser to former President Barack Obama.

Details of how the Federal Deposit Insurance Corp., which took control of Silicon Valley Bank on Friday, is dissolving the bank could affect any spillovers to the rest of the banking system, especially small and medium-sized banks with a similar profile.

SVB has been heavily focused on lending to venture capital firms, and the eventual resolution of the bank’s assets could have broader implications for endowments and pension funds that have increased their exposure to venture capital, said Mr. Rosengren.

Fed officials slowed their pace of rate hikes last month when they raised their benchmark rate by a quarter of a percentage point to a range between 4.5% and 4.75%. That followed increases of a larger 0.5 percentage point in December and 0.75 percentage point in November and three previous meetings.

Officials said last month that by going in smaller steps they would be better able to assess the effects of their rapid increases last year and mitigate the risk of too many rate hikes.

Mr Powell said this week that officials at their upcoming meeting are likely to project raising rates to higher levels than they previously expected to lower inflation. In December, most of them thought they would raise Fed Funds rates to between 5% and 5.5% this year.

Since Fed officials last met on Feb. 1, several economic reports have revealed that hiring, spending and inflation came in stronger than expected in January. More importantly, data revisions showed that inflation and labor demand did not decline as much as initially reported at the end of last year.

“We’re actually seeing a reversal of what we thought we were seeing to some extent,” said Mr. Powell Tuesday. “Nothing about the data suggests we tightened up too much.”

The Fed has tried to curb investment, spending and hiring by raising rates, making it more expensive to borrow and allowing the price of assets such as stocks and real estate to fall. The fed-funds rate influences other borrowing costs throughout the economy.

Write to Nick Timiraos at Nick.Timiraos@wsj.com