The U.S. economy is once again underperforming expectations, as it has in the first quarter of the past five years. Yet despite the recent slowdown, the economy is ready for a Federal Reserve (Fed) interest rate hike.
Indeed, as my colleagues and I write in our new BlackRock Investment Institute paper, “When the Fed Yields,” “zero is the wrong number for short-term rates” today, because there are clear signs that the U.S. economy already exhibits much of what the Fed has said it wants to see on the jobs and inflation front before raising short-term interest rates.
Solid jobs growth.
The BlackRock U.S. Employment Index—our gauge of 10 key labor market indicators—has risen back to pre-crisis levels. All of the index’s subcomponents have turned positive this year, as the chart below shows.
In addition, April’s payroll report reaffirmed the strong, and generally consistent, run in payroll growth that weak March figures had seemingly called into question. According to the report, more jobs have been created over the past 24 months than over the 13 years previous to that combined. Jobs growth has been pretty steady (despite a March blip)—and given the April rebound in payrolls, it’s hard to see this trend changing any time soon. In fact, the last time that 12-month non-farm payrolls job growth was as strong as it is today, the early 2000s, the Fed’s policy rate stood near 6% (versus effectively zero today).
Additionally, while average hourly earnings (AHE) still appeared sluggish in April’s payroll report, there are other indicators of growing wage pressure. The recent strong Employment Cost Index report, alongside robust permanent and temporary hiring surveys, suggest that there is a significant lack of qualified workers for hire at this point, or in other words, that labor markets are tightening.
A trough in inflation.
Falling oil prices and the strong U.S. dollar have dampened headline consumer price index (CPI) inflation, but the recent core CPI print suggests a clear firming in inflationary conditions. In addition, 10-year U.S. inflation expectations are now at the highest level since October, though still below last year’s level.
To be sure, the Fed’s preferred core inflation gauge—personal consumption expenditures (PCE)—stood at just 1.4% in March. This is well below the central bank’s 2% target. However, the Fed has said it doesn’t expect to see inflation hit its target before raising rates. The effects of an aging population and rapid technological innovation are suppressing inflation and nominal growth, and goods prices have been stagnant over the past five years, dragging overall inflation lower.
The above, coupled with stable markets and easy monetary policy elsewhere in the world (most notably in Europe and Japan), argues for raising the short-term rate sooner rather than later. April’s jobs report makes a case that the Fed’s initial policy rate hike should begin September, with a gradual pace of movement from there. Policy rate normalization should not only be borne well by the economy, but it may actually hold a positive impact.
Should the economy bounce back later this year, it would be both disheartening and potentially destabilizing if the Fed were to squander this window of opportunity to make an initial rate move in 2015.
“Emergency” accommodation has overstayed its welcome, and keeping rates excessively accommodative almost certainly holds an increased risk for markets. The Fed’s highly accommodative monetary policy has inflated asset values across global markets. The longer the Fed leaves its target rate at zero, the greater the chance of asset price bubbles—and eventual crashes.
For more on the dynamics and impact of a potential Fed rate increase, be sure to check out the full BlackRock Investment Institute paper.
Sources: BlackRock research, BlackRock Investment Institute, U.S. Department of Labor Bureau of Labor Statistics
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.