Hawks will rule the nest: Ultra-low unemployment could see the Fed hike rates 4 more times next year

  • RBC is forecasting that US unemployment will fall below 3.5% by the middle of next year.
  • It says such a scenario may see the US Federal Reserve hike interest rates four times rather than three in 2019.
  • The US non-farm payrolls report for October will be released today. Unemployment is expected to remain at 3.7%, the lowest level since 1969.

US unemployment is likely to fall more than many think, including the US Federal Reserve, setting up a scenario where it may have to hike interest rates four times rather three in 2019, says Tom Porcelli, Chief US Economist at RBC Capital Economics.

“We think by mid-2019 we’ll be contending with an unemployment rate below 3.5% and an inflation rate at or slightly above the 2% target,” he said in a note ahead of October’s non-farm payrolls report on Friday.

“This will embolden the [Fed] to hike four times in all of 2019.”

Yes. Four.

Not three as indicated by the median FOMC Fed funds rate forecast offered in September, and double the two hikes currently favoured by financial markets.

So why is Porcelli so confident that unemployment, already sitting at 3.7%, the lowest level since 1969, will continue to grind lower, moving beyond the 3.5% nadir currently expected by the Fed?

Job openings — a record amount of them, whether measured by total number or as a percentage of the US labour force.

“With job openings currently sitting at north of seven million and economic growth likely to clock in near 3% through the middle of next year, a material slowing in payroll growth seems unlikely,” he says.

“The downward pressure on the unemployment rate is set to continue unless we downshift significantly in terms of monthly payroll growth.”

This chart from RBC shows where US unemployment will move based on average monthly payrolls growth with recent trends in population growth and labour force participation maintained.


To get to 3.5% where the Fed expects it to bottom, it would take average payrolls growth of around 125,000, near-half the 203,000 average seen over the past six months.

While many expect hiring to slow as labour market conditions tighten, making it harder for firms to find suitable staff, Porcelli says even if that happens unemployment could easily fall much further in a relatively quick period of time.

“If payroll growth manages to clock in at better than 175,000 per month over the course of the next 18 months, the unemployment rate would fall below 3%,” he says.

“At 150,000 per month it would take until early 2021 for it to fall below that threshold.”

Given Porcelli sees unemployment falling through 3.5% by the middle of next year, that should help to boost wage pressures and incomes, helping to explain why he sees GDP growth remaining above potential and, as such, the prospect of a more aggressive Fed.

The October payrolls report will be released at 8.30am EDT (11.30pm AEDT).

Unemployment is expected to remain steady at 3.7%.