The last time unemployment claims were this low, in 1973, the Federal Reserve chair was the last one to lose control of inflation: Arthur Burns.
In Burns’ defense he faced outrageous political pressure from Richard Nixon, not to mention the inflation and economic nightmare of the Arab oil embargo, but still it would be hard to blame Janet Yellen for feeling a bit of a chill at the back of her neck.
The market does not expect it, and doubtless will hate it, but September is not too soon for the Fed to lift interest rates.
US jobless claims fell by 26,000 last week to 255,000, the lowest such figure in 41-1/2 years. The less volatile four-week moving average fell 4,000 to 278,500 and is just 12,000 above the 15-year low recorded in May. The Conference Board also said its Leading Economic Index rose by 0.6% last month, building on May’s 0.8% rise, helped in part by strength in the housing market.
Add to that strong growth in the Atlanta Fed’s GDPNow real-time indicator, which is forecasting real economic growth in the second quarter of 2.4%. This compares to a readout of less than 1% as late as early June.
Inflation, of course, remains contained. Core inflation is up 1.8% in the year to June. The Personal Consumption Expenditures inflation rate, which the Fed prefers, is up only 1.2% annually.
Yellen herself has sounded far more willing to entertain a rise in rates sooner rather than later.
“I would say … our economy is in a much better state,” she told Congress last week. “Low interest rates have facilitated it, and a decision on our part to raise rates will say, ‘No, the economy doesn’t stink.’ We’re close to where we want to be, and now think the economy can not only tolerate but needs higher rates.”
The economy may not be in overdrive, but it clearly does not stink.
What is mildly surprising is how reluctant financial markets are to price in rate rises. Federal funds futures, which allow investors to bet on where rates will be in the future, are only pricing in a 17% chance of an increase at the September meeting and zero chance of a move when the Federal Open Market Committee meets next week.
Safe and practical
Two excellent and sharply diverging lines of reasoning support raising rates now, one practical and one precautionary.
To be safe, Yellen and company need to get out in front of an economy which is doing quite respectably on all fronts save wages and inflation. From a practical standpoint, the Fed should not wait so long that they are overtaken not by inflation but by the next downturn. Remember, exceptionally low levels of jobless claims don’t just tell you about the current economy; they have also often preceded, by not too much, recessions.
Especially given the mixed reviews and outcomes from asset purchases, the US central bank is going to want to have some room for rate cuts before the next time the economy weakens.
Given that we are likely looking at a slow and uneven rate-rise campaign, rather than a hike a meeting, time is of the essence.
As a percentage of the civilian labor force, unemployment claims are just higher than a record low. Cyclical lows in this indicator occurred not long before, or just at the start, of the last seven recessions stretching back to 1969.
That too argues for not waiting.
As well, the Fed does not want to get caught short by a buildup in inflation.
“Given the lags in monetary policy transmission, by the time wage and price pressures become obvious to financial market participants and policymakers, it will be too late: The Fed will be forced to play catch-up,” Deutsche Bank economist Joseph LaVorgna wrote in a note to clients.
“This would imply a much faster trajectory for rates than what financial markets currently assume.”
This last point, market expectations, is a difficult one for the Fed. It may be unwise, but the central bank has been extremely solicitous of financial market mood since the great recession. As well, longer-term inflation expectations in financial markets have been sinking, indicating that many investors are taking a view that current low inflation is structural.
Expect the Fed to spend the next weeks doing two things: gently hinting that the rate rise is coming, and also stressing that hikes will be gradual, and can be reversed if needed.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
