Market, Omicron risks pose new challenge for Fed policy pivot

WASHINGTON, Jan 20 (Reuters) – U.S. Federal Reserve officials, having plotted what seemed a clear battle plan against high inflation, must now contend with fresh signs the coronavirus is again slowing the economy as well as markets conspiring to tighten financial conditions faster than Fed policymakers may have hoped.

The combination of economic data pulling in one direction and investors in another could make the Fed’s meeting next week unexpectedly complex as policymakers try to balance continued uncertainty over the health crisis against markets adjusting fast around projections the Fed may need to act even more aggressively against inflation.

The central bank has been clear interest rates will rise this year – at its December meeting every official expected at least one rate increase and half expected three – and that it would also reduce its $9 trillion stock of assets as a second means to tighten monetary policy. Next week’s session was seen allowing them to start refining the message of a likely initial interest rate increase in March with a balance sheet reduction later in the year.

But the stakes have gotten higher.

Data from payroll provider UKG showed shift work decreased by 5% for the week ending Jan. 16 compared to the week before, a sign coronavirus infections may produce another disappointing employment report in January after job growth of just 199,000 in December.

Initial unemployment claims unexpectedly rose to 286,000 the week ending last Saturday, the highest level since mid-October.

While some of that is due to volatile seasonal patterns in the data “this increase is much more about the hit from Omicron,” wrote Ian Shepherdson, chief economist with Pantheon Macroeconomics. “It won’t last long…but the near-term path of claims is now very unpredictable.”

He said he now expects the January jobs report to show a loss of 300,000 payroll positions and “we’d be surprised to see much improvement in February,” the last bit of jobs data the Fed will get before a likely March decision to raise interest rates.

Recent retail spending data were also disappointing and other real-time measures of economic activity have dipped

“The recovery weakened a bit more” said Oxford Economics economist Oren Klachkin. The firm’s index of the recovery had hit 100 in October before slipping in recent weeks.

Fed officials are hopeful the pandemic’s drag on the economy eases soon, and the daily pace of infections does appear to be slowing.

But other risks to the recovery remain, including a decline in federal government spending that has helped support household disposable income throughout the pandemic.

The Fed is treating signs of sluggish growth “as temporary, due entirely to Omicron-related disruptions,” wrote Natixis chief economist Joseph Lavorgna. “This would be a mistake. There is going to be a historic tightening of fiscal conditions this year…The hiking of…