After the weaker-than-expected August non-farm payrolls report, many market watchers are speculating that the Federal Reserve (Fed) will stick with a mid-2015 time frame for raising rates and won’t be announcing an earlier-than-expected rate hike at its upcoming September meeting.
In my opinion, however, we could still see a rate policy transition earlier than many anticipate. Here are three reasons why.
Despite the disappointing August data, the labor market is improving. First, I wouldn’t put too much weight on August’s weak numbers. Summer is traditionally a weak period for hiring and August jobs report numbers are often revised higher.
In fact, 14 of the last 18 August payroll reports have been below expectations, while 12 of the last 14 August employment releases have ultimately been revised higher. Hence, I’m eagerly awaiting the normal revisions to this number. In the meantime, with prior 3-month, 6-month, and 12-month moving average nonfarm payroll gains of 207,000, 226,000 and 207,000, respectively, the current run-rate in job creation is still on par with that of past periods of economic expansion.
In addition, other labor market indicators are pointing toward improving conditions. The U-6 unemployment rate has been declining to dramatically lower levels; initial jobless claims remain around pre-crisis levels; and metrics from Fed Chair Yellen’s favorite labor market indicator – the JOLTs report – are consistent with pre-crisis readings.
Indeed, my team has created an index of various labor market readings, which we’ve dubbed the “Yellen Index,” to gauge how the labor market compares to periods over the past 11 years. The index’s recent readings have been at levels last seen prior to the middle of 2008, and they’re approaching levels last seen before the onset of the last financial crisis, i.e. when rates were much higher than they are today.
Finally, while some cite an extremely low labor force participation rate as a cause for concern, I believe this is largely a function of structural and demographic factors, and consequentially remains beyond the scope of meaningful monetary policy influence.
Inflation data are firming. Another reason I think the Fed is likely to move sooner than many believe is the growing evidence that tighter short-term labor market conditions are beginning to spur some wage inflation. While this inflation is mostly occurring for those with specific skill-sets that employers deem valuable, wages for non-supervisory and production workers have also been ticking up. In fact, in Friday’s August jobs report, they were up 2.5% year over year, a year-over-year increase not seen since a few years ago. Beyond mere wage inflation, there has been a broad-based firming in a range of inflation data in the first half of the year, including consumer price index levels, producer price index levels and personal consumption expenditures index levels, all of which are considerably higher than the beginning of 2014 and well above year-prior levels.
Excessively low rates may be harmful to the economy. Lastly, as I mentioned in an earlier post, the Fed’s zero interest rate policy may actually be inhibiting economic growth and job creation in unintended ways. Among the negative side effects of excessively low rates: older workers are staying in the workforce longer, crowding out younger workers, and companies are wary of committing capital, delaying or reducing investment and hiring.
In short, recent improvements in labor markets, firming inflation data and the harmful impact of excessively low rates suggest that the notion of maintaining monetary policy accommodation at “emergency levels” for these “unusual times” appears dubious. Supporting full employment and seeking general price stability are the Fed’s well-known statutory mandates, and the status of both suggests that rate policy may be in transition earlier than many anticipate, and that the Fed can move sooner rather than later toward a higher short-term funds rate.
In the wake of the Federal Reserve’s Jackson Hole, Wyoming symposium in late August, I believe the Fed has started to acknowledge the labor market improvement, and I’m now watching for a policy transition announcement at the mid-September Federal Open Market Committee meeting and press conference.
Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Fundamental Fixed Income, is Co-head of Americas Fixed Income, and is a regular contributor to The Blog. You can find more of his posts here.