Fed Sees Labor-Market Slack Even After Unemployment Rate Dropped

The Federal Reserve said the labor market still has plenty of room for improvement, even after a surprising drop in unemployment, bolstering the case for keeping interest rates low.

“A range of labor-market indicators suggests that there remains significant underutilization of labor resources,” the Federal Open Market Committee said today in a statement in Washington, dropping language that unemployment is “elevated.” The Fed also said inflation has risen closer to its goal.

The statement highlights broader measures of the labor market, such as weak wage growth and underemployment, that Fed Chair Janet Yellen has emphasized as reasons for maintaining more than five years of near-zero rates.

“It reflects Chair Yellen’s firmly held belief that there’s still major slack in the labor market and as part of their mandate they need to continue to provide accommodation for some time,” said Terry Sheehan, an economic analyst at Stone & McCarthy Research Associates in Princeton, New Jersey.

Policy makers continued to trim the asset purchases that have pumped up the Fed’s balance sheet to a record $4.41 trillion. They tapered monthly bond buying to $25 billion in their sixth consecutive $10-billion cut, staying on pace to end the purchase program in October.

Stocks were little changed while bonds remained lower. The Standard & Poor’s 500 Index increased less than 0.1 percent to 1,970.10 at the 4 p.m. close of trading in New York, while the yield on the 10-year Treasury note rose 10 basis points to 2.56 percent.

‘Measured Steps’

The FOMC repeated it’s likely to reduce bond buying in “further measured steps” and to keep interest rates low for a “considerable time” after ending purchases.

“The likelihood of inflation running persistently below 2 percent has diminished somewhat,” the Fed also said. Its preferred inflation gauge -- the personal consumption expenditure price index -- rose 1.8 percent in May from a year earlier. That’s up from a gain of 0.8 percent in February.

“They are protecting their credibility” by flagging less risk that inflation will stay below their target, said Mark Vitner, senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “Inflation has moved from a reason for the Fed to be easier for longer to more of a neutral factor in policy.”

Plosser Dissent

Philadelphia Fed President Charles Plosser dissented, objecting that the guidance on the timing of a rate increase was “time dependent” and didn’t reflect “considerable economic progress.”

The outlook brightened today with a government report showing the economy expanded more than forecast in the second quarter. Gross domestic product grew at a 4 percent annualized pace, after a 2.1 percent contraction in the previous three months.

Since meeting in mid-June, the committee has come closer to achieving its goals for stable prices and full employment. Employers added 288,000 jobs last month, helping push down unemployment to 6.1 percent, the lowest in almost six years.

Consumers, whose spending accounts for 70 percent of the economy, have grown more confident as the labor market improves and rising share prices boost wealth.

The S&P 500 is up more than 6 percent this year after jumping almost 30 percent last year, aided by easy monetary policy and rising corporate profits.

Corporate Profits

Almost 77 percent of companies in the S&P 500 have posted second-quarter results that exceeded analysts’ estimates, according to data compiled by Bloomberg.

Yellen told lawmakers this month that while her view of the economy has turned “more positive,” she’s concerned about signs of job-market “slack” such as low participation in the labor force.

“We need to be careful to make sure that the economy is on a solid trajectory before we consider raising interest rates,” she said in her semi-annual testimony. “There are mixed signals.”

Among them: average hourly earnings fell or were stagnant in the past four months, after adjusting for inflation.

“The most important thing is to look at what’s going on with hourly wages,” according to Brian Jacobsen, who helps oversee $232 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin.

Before it's here, it's on the Bloomberg Terminal.