The U.S. Federal Reserve (Fed) has suggested it’s likely to remain on hold for the near future given Brexit-related uncertainty and tightening financial conditions.
A moderating global growth dynamic and very easy monetary policy abroad are also forces keeping the central bank from initiating more rate normalization. Perhaps more importantly, closer to home, there’s one more reason we should expect interest rates in the U.S. to be lower for longer: The strong pace of U.S. jobs growth seen over the past few years has moderated recently and is unlikely to be sustained at historically high levels, as reduced corporate profits and political.
Just about right
But what about June’s strong jobs growth? I believe May’s poor jobs growth was an aberration as was June’s better-than-expected report, but the average of the two seems about right. The very poor headline data in May overstated labour market weakening and didn’t reflect that the U.S. economy is still doing reasonably well. Meanwhile, the June gain included the 35,000 boost from Verizon workers returning from their strike, and the inevitability of a bounce from the weak April and May releases, so the headline print may be a bit less meaningful after delving into the details.
In fact, despite the strong headline numbers, June’s report did bring some signs of a slowing big picture. April and May jobs numbers, when combined, were revised slightly downward by a total of 6,000 fewer jobs than previously reported. In addition, the most recent payrolls print brought the 3-month, 6-month and 12-month moving average payroll gains to 147,000, 172,000 and 204,000, respectively. While these levels are modestly higher than May, they still show a slowing trend.
Rising minimum wage and jobs growth slowdown
Finally, wage gains can come alongside weakening payrolls given the diminishing pool of qualified unemployed applicants and broad-based labour market tightness, and moderate wage gains do represent a headwind to payroll growth going forward. Over the next two years, several states plan to raise statutory minimum wage rates, adding to the upward pressure on wages. When wage costs are increased through policy rather than via market mechanisms, revenues and profits can take a hit unless businesses have the pricing power to charge customers more. The net result could well be lower levels of hiring in strong areas of jobs growth, such as the leisure and hospitality sectors.
It’s important to note, though, that I see a moderate jobs growth slowdown ahead, rather than an aggressive one. But given that strong labour markets have been one of the hallmarks of the past few years of U.S. expansion, any persistent slowing in this area would certainly make raising rates much more difficult for the Fed. Ultimately, I believe interest rates should be normalized at a measured pace. It’s clear to me that the economic effectiveness of excessively low rates in stimulating economic growth has been significantly diminished in recent years.
Lower for longer
Slowing U.S. labour market growth combined with the other factors mentioned above will make normalization this year difficult for the Fed. However, we still believe the Fed will try to raise rates later this year, but it very likely won’t get a chance to do so in the near term, as we do not foresee much pressure on the central bank to resume rate normalization. In the end, investors will have to contend with rates that are much lower for longer and the fact that generating return in fixed income markets will continue to be challenging, requiring a different toolkit than the traditional one previously used.