There is a debate about the labor markets. Are they getting better?
There are various ways to measure the relationship between the labor markets and the economy. We like the Beveridge curves, named for a famous economist who did serious work on labor markets many years ago, depicting the relationship between unemployment and the job vacancy rate. We have taken William Beveridge’s structure, adapted it to the modern version of data, and applied it to various measures of the unemployment rate. The resulting slides can be viewed by visiting the “Special Reports” section of our website. Notice how the curves are strongly rising from various depressed levels. In many cases they have reached levels close to prior peaks.
The Beveridge curves indicate that the labor markets are improving at an accelerating rate. That is a good thing. But what does that mean for Federal Reserve policy? Will there be an acceleration of the rise in interest rates in 2015 if labor markets continue in this positive recovery mode?
We talked about that at the conference in Wyoming. The question was the subject of pre-meeting discussions as well. Federal Reserve officials, economists, and others in the financial world presented their various views. Those slides and presentations are available on the Global Interdependence Center’s website (www.interdependence.org). The speeches of our Federal Reserve officials and others are also available on that website for those who missed the news coverage of the event.
The bottom line is that the labor markets seem to be getting better. We have not yet seen intense upward pressure in labor costs. Will we see them? That is the opening question.
The second question is whether or not that upward pressure will flow through to become a transmission mechanism for inflation pressures.
Lastly, if we get “yes” answers to questions one and two, will those pressures be reflected in higher interest rates or expectations of higher interest rates? We think that answer is also “yes.”
The Fed would like to achieve a benign gradualism in making its policy transition. It may not get it. Safety says hedge bonds, shorten up duration, build a little cash reserve, be nimble. That seems like a reasonable investment strategy. At least we think so.
BY David R. Kotok