As we gear up for one of the most uncertain US rate decisions in recent times, we weigh in the options and argue what components the Fed should look at before increasing interest rates.
US unemployment continues to decrease, coming in at 4.4% for April. The Fed’s medium expectation rate from 2017 to 2019 is at 4.5%. Does this mean that the Fed will lift interest rate forecasts in the upcoming meeting? No, probably not.
There are a lot of variables at play, each with the potential to offset the impact of declining unemployment. If the Fed ignore these other components, the body is making a large bet that the economy is close to overheating and that to keep growth steady, the economy requires a tightening of monetary policy.
Components such as inflation, the natural rate of unemployment and neutral interest rate all play a major role in the estimations of future rate hikes.
Inflation and the natural rate of employment look to be under pressure. Thanks to the lack of inflation and wage growth the Fed have previously reduced expectations for the natural rate.
It seems that the Fed should rethink its forecast for unemployment. Even the lowest of all member’s predictions is at the current level. The robust US growth, the Fed should expect a further decline in unemployment.
If the Fed decide that unemployment will come down, there should be an uptick in the amount of rate increases to help tamper inflation, opening a potential fourth rate hike for this year.
However, how reliable is the unemployment rate to gauge the US economy?
For those steering the nation’s monetary policy low unemployment is a great indication of economic health, although it does not tell the full story.
The labour participation rate should be closely examined when conducting analysis and deciphering whether the US has truly reached such low unemployment.
The labour participation rate, described as the percentage of able and willing Americans who are an active part of the labour force – this figure is somewhat depressed. While, US wage growth is slacking, there is no driving force pulling workers back into the labour force. This means that the unemployment rate could be slightly skewed by the lagging wage stimulus.
The capacity of the labour participation rate and the extent by which government policy can pull the remaining population into the labour force should be paramount to any analysis of future rate increases. Are there additional people who could still be pulled back into the workforce?
Yes, probably. There is a large amount of able workers are not being included in the workforce, many of them men aged 25-54 who are neither working or looking for work. Additionally, given the high cost of childcare in the US, many women never return to work after having children as the costs are too high.