Plunging Unemployment Bolsters Case for Earlier Fed Rate Rise
A plunge in U.S. unemployment to the lowest level in more than five years bolsters the case for Federal Reserve officials to raise the main interest rate earlier than they forecast just three weeks ago.
Payrolls surged in June by 288,000 workers and unemployment fell to 6.1 percent, a level that Fed officials didn’t expect to see before the end of the year, a government report showed yesterday. Further job gains would probably prompt the Fed in September to raise its projections for the benchmark interest rate at the end of 2015 and 2016, said Roberto Perli, a partner at Cornerstone Macro LP in Washington.
“If the recent trend in the labor market continues, the next FOMC interest-rate projections should be even higher,” Perli said in a note to clients, referring to the Federal Open Market Committee. (FDTR) “With inflation approaching the 2 percent target and the unemployment rate continuing to decline, the odds that the Fed will lift rates off of zero sooner than the market expects are increasing,” said Perli, former associate director of the Fed’s Division of Monetary Affairs.
Wall Street economists, responding to the jobs report, pushed forward estimates for the first Fed interest-rate increase since 2006.
“The stellar jobs report hits the Fed right between the eyes on how good labor-market conditions out there truly are,” said Chris Rupkey, chief financial economist for Bank of Tokyo-Mitsubishi UFJ in New York. “It shows how far behind the curve they are,” he said, adding that he now expects the first rate increase in March next year instead of June.
Fed officials predicted last month their target rate will be 1.13 percent at the end of 2015 and 2.5 percent a year later. They have held the main rate near zero since December 2008.
Investors expect the central bank to be even slower in moving up rates, according to implied yields on federal funds futures contracts traded on the CME Group Inc. exchange. The funds rate will be 0.78 percent by the end of next year and 1.81 percent by December 2016, the contracts signal.
With gains in employment and inflation accelerating, “the narrative will begin to shift to an earlier first rate hike,” according to John Ryding, chief economist at RDQ Economics in New York and a former economist at the New York Fed.
“If the Fed does not adjust its guidance, it will make a mockery of the notion of data-dependent policy,” Ryding said. He expects the first rate rise in March.
“So far, the doves at the Fed have continued to preach a very slow path to normalization,” said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut. “This approach should now be considered under fire,” he said in a note to clients. He moved his projection for the first rate increase to June 2015 from September 2015.
The benchmark 10-year Treasury yield climbed to a two-month high of 2.69 percent after the report before paring gains to 2.64 percent. The Standard & Poor’s 500 Index advanced 0.6 percent to close at a record 1,985.44. U.S. equity markets are closed today for the Independence Day holiday.
Fed officials are debating how long to keep the benchmark federal funds rate near zero after completing a bond-buying program that’s set to end late this year. The committee repeated on June 18 that it expects the rate to remain near zero for a “considerable time” after the purchases end.
The central bank plans to release minutes from the June FOMC gathering on July 9. The next meeting is scheduled for July 29-30. Policy makers are scheduled to update their projections for the economy and interest rates for a Sept. 16-17 meeting.
St. Louis Fed President James Bullard said last week he favors raising the benchmark rate in the first quarter.
“The economy could tolerate at least a little bit of the central bank getting back to a more normal stance,” Bullard, who doesn’t vote on policy this year, said in New York. He cautioned against underestimating the pace of progress toward the Fed’s dual mandate of full employment and price stability.
The jobs report may help push the Fed to increase the benchmark interest rate by the first quarter, according to Rick Rieder, New York-based BlackRock Inc.’s chief investment officer for fundamental fixed income.
“The Fed will move faster than people think because the data is extraordinarily compelling,” Rieder said yesterday in a Bloomberg Television interview.
The view that the Fed will tighten sooner isn’t universally held. Pacific Investment Management Co.’s Bill Gross said wage growth that is keeping inflation below the Fed’s 2 percent target will prompt the central bank to continue pursuing a slow, below-average pace for raising interest rates.
“It’s actually the wage number that is critical and the jobs that takes second seat,” Pimco’s Gross said in a radio interview on “Bloomberg Surveillance” with Tom Keene and Mike McKee. “In order to get to the 2 percent inflation target that the Fed wants to get to, assuming a 1 percent productivity number, you are going to have to see wages at 3 percent plus. So the Fed is willing to stay put here.”
Average hourly earnings rose by 0.2 percent for a second month, to $24.45 in June from the prior month, and increased 2 percent over the past 12 months, yesterday’s report said.
Fed officials favoring persistent stimulus can find ammunition in weak wage growth, said Tim Duy, a professor at the University of Oregon in Eugene and a former U.S. Treasury Department economist.
“Although a solid report, the doves can still lean on persistent underemployment and, in particular, subdued wage growth,” he said. “Wage growth is the kind of evidence of tighter labor markets that would have a more dramatic impact.”
Still, “this report suggests that the risks are weighted more toward the second quarter than the third,” he said, referring to the probable timing for the first increase in the main interest rate.
Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York, pulled forward his forecast for Fed tightening by one quarter after the jobs report, projecting the policy shift will start in the third quarter of 2015. The bank sees the federal funds rate at 1 percent by the end of that year and at 2.5 percent in 2016.
“The inexorable decline in the unemployment rate, alongside firming core PCE inflation, is dramatically reducing the degree to which the Fed is missing on its mandate,” Feroli said yesterday in a note to clients.
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