The Fed is going to raise rates in June.
The labour market is rolling, the economy is humming along, and inflation is stable — excluding the decline in gas prices, which Fed chair Janet Yellen has called transitory.
On Thursday morning, the latest report on initial jobless claims showed claims totaled 282,000 last week. It was fewer than expected, but still another solid print from our most frequent pulse on the labour market.
Following the initial claims figure, the latest flash services PMI number from Markit Economics was a beat, with a reading of 58.6 against expectations for 57.0. (Any reading below 50 indicates contraction, any above 50 indicates expansion.)
Markit said this report, “signalled a robust and accelerated expansion of service sector output,” and added that “March data indicated a strong and accelerated expansion of incoming new work across the U.S. service sector.”
In short, things are good out there.
In a note to clients on Thursday following the initial claims number, Ian Shepherdson at Pantheon Macro wrote:
Yet another labour market report confounding the market’s current favourite narrative, that the economy has slowed to such an extent that the Fed won’t hike until July at the earliest. If claims are sustained at this level, or anything like it, and hiring indicators remain at current levels, then payroll growth will remain very rapid and the steady decline in the unemployment rate will continue, pushing it into the Fed’s newly-lowered Nairu range in time for the June FOMC meeting.
In its latest policy announcement, the Fed cut its outlook for its new NAIRU range — the non-accelerating inflation rate of unemployment, or the unemployment rate at which inflation begins to pick up — to 5.2%-5.0%. In February, the unemployment rate was at 5.5%. But this was down from 5.8% in November, and as we wrote last week, the market reacted to the Fed’s new unemployment projection as if the labour market had no chance to outperform the Fed’s expectations.
However, the labour market has been beating the Fed’s expectations for years. And in a note earlier this week, David Mericle at Goldman Sachs noted that, “Monthly payroll employment gains have averaged 293k over the last 6 months.” In 2014, job creation hit its highest level since 1999.
In that same note, however, Mericle said the recent job gains could be as good as it gets. He said the labour might be running “too hot” right now. Maybe so.
But right now current data don’t indicate a slowdown in the labour market, and the prospect of the unemployment falling to 5.2% — or the upper-edge of the Fed’s NAIRU range — by May is very real.
In Markit’s flash PMI report, Williamson said, “The US economy is showing signs of regaining momentum after the slowdown seen at the turn of the year. The flash PMI surveys are registering faster growth of both service sector and factory activity at the end of the first quarter, as well as ongoing strong hiring.”
A shutdown at West Coast ports in the beginning of the year and some harsh winter weather is expected to keep first quarter GDP subdued, with Markit’s Chris Williamson expecting GDP to slow from the 2.2% pace seen in the fourth quarter of 2014.
But the labour market is simply on fire.
When folks bring up the strength of the labour market, others are quick to note the Fed’s dual mandate — full employment and price stability — highlighting that the Fed has said it is aiming for inflation running at 2%.
But the Fed doesn’t need inflation to hit 2% to begin raising rates.
Earlier this week, we got inflation figures that showed excluding the price of food and gas, inflation rose 1.7% over the prior year in February. So you might say this means the Fed can’t raise rates. But the Fed has made clear it isn’t looking for a 2% inflation print to raise rates, saying that instead it will need to have reasonable confidence inflation will get to 2% over the medium-term.
The biggest thing that gets overlooked when talking about the
first rate hike is what rates look like over the course of the Fed’s tightening cycle.
In a speech at the Economic Club of New York on Monday, Fed vice chair Stanley Fischer made this point, saying that he expects the Fed will raise rates this year but said that once the Fed begins raising rates, the path of rates wouldn’t necessarily be predictable or steady.
The key line from Fischer is when he said, “a smooth path upward in the federal funds rate will almost certainly not be realised, because, inevitably, the economy will encounter shocks — shocks like the unexpected decline in the price of oil, or geopolitical developments that may have major budgetary and confidence implications, or a burst of greater productivity growth, as the Fed dealt with in the mid-1990s.”
And so the first rate hike doesn’t necessarily usher in a regime of steadily tightening the screws, but signals that the Fed has begun an exploratory process where it raises rates and see how markets and the economy digest the change.
Again, recall that Goldman’s Mericle thinks the labour market might be running “too hot.” Fine. But right now there are no signals that the trend will reverse in the coming months. And if the labour market keeps running at this pace through the spring, the Fed will likely be looking at economic conditions that are as good as it gets to raise rates.
June it is.