United States

Blowout jobs report points to December rate hike


Private sector hiring returned to form in the October jobs report and the labor market reached full employment at 5 percent, which should provide enough cover for the U.S. Federal Reserve to raise rates in December for the first time since June 2006. The 271,000 new jobs added in October, coupled with better recent economic data and evidence of modestly rising wages, suggest the economy’s soft patch has abated.

Our preferred metric for unemployment, the U6-U3 spread, or the spread between the unemployment rate which includes discouraged workers and all other marginally attached workers (U6) and the official unemployment rate (U3), fell to 4.8 percent, just above the spread’s long-term average of 4.6 percent.

On another encouraging note, one labor market metric that Fed Chair Janet Yellen watches closely, involuntary part-time employment, declined to 5.767 million in October, though it’s still slightly above the historical pace of 5.4 million. Given the direction of the labor market, this is traditionally the point when central bankers begin to consider the impact of a tight labor market on wages and inflation and move toward tightening rates.

With labor growth of one half of 1 percent per year, the economy needs to generate about 100,000 per month to meet the demands of new entrants into the labor market. With a long-term growth rate of 1.5 percent (1 percent productivity plus one-half percent growth in the labor market) job gains at the current six-month pace of 215,000, and a growth rate above 2 percent, both point to a reduction in overall economic and labor slack which, over time, will require a net tightening of policy.

October’s pace of job creation implies that the August and September readings were transitory deviations from the underlying trend, which should continue to produce job growth near 200,000 per month into 2016. At this point, with only 1.4 unemployed individuals available per job opening, the labor market is sufficiently tight to withstand a modest series of rate hikes that will unfold next year.

It is important to recognize that the Fed is intent on raising rates in a gradual and orderly manner that will unfold over a period of years, versus the sharp series of rate increases seen during the Alan Greenspan-led Fed in the 1990s. That is why, in our estimation, any worries about a rapid rise in interest rates, which will likely dominate market chatter during the next few weeks, has the potential to be misleading.

At this point in the business cycle, with the labor market continuing to tighten, policymakers will interpret any job gains between 100,000 and 150,000 as sufficient to continue to slowly bring down the unemployment rate at a pace commensurate with a gradual normalization of monetary policy.

Looking forward to 2016, we anticipate another 50 basis points of tightening prior to the U.S. presidential election, which may pose challenges for interest rate-sensitive sectors such as housing and autos, both of which have shown robust growth during the past several months.


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