Green Light, by Tim Duy: If there was truly any potential impediment to a rate hike from the Fed this week, it would have come from a weak employment report. The employment report was decidedly not weak. Instead, it finished paving the way to a Fed rate hike. Not enough yet, however, to justify a dramatic acceleration in the pace of future rate hikes, implying only a 25bp upward nudge in the Fed’s rate projections for 2017.
Nonfarm payroll growth came in above expected at 235k:
The number may have been boosted by mild weather in February. Still, the underlying pace of growth in recent months is around 200k/month. This is faster than the Fed expects necessary to hold unemployment steady after the cyclical boost to labor force participation plays out. So far, however, labor supply continues to respond. Labor force participation edged up during the month, leaving the decline in the unemployment rate a modest 0.1 percentage points to 4.7 percent. This is just a touch below the Fed’s estimate of NAIRU.
Underemployment numbers to continue to improve, as the Fed expects:
The economy is at something of a sweet spot, with job growth strong enough to prod along continued healing of the labor market but slow enough that the Fed can continue to remove accommodation at a gradual pace.
Wage growth rebounded in February, continuing to hover in the 2.5-3 percent range:
Should we be expecting much faster wage growth? Probably not. It strikes me that we are closing in on pre-recession rates:
If inflation rises to two percent (and here I am thinking core inflation), and wages rise with it, that adds about 30bp which pushes wage growth a bit above three percent. Note also, real wage growth was likely a touch higher prior to the recession, but not much:
And this needs to be taken in context of falling productivity growth over the past two decades:
So in order to expect substantially faster wage growth, we need to expect substantially higher productivity growth or substantially higher inflation. The Fed is betting against the former and actively tries to contain the latter. Indeed, on the latter they are only looking to get another 30bp or so. Which suggests to me that a meaningful acceleration of wages at this point would be interpreted by the Fed as evidence they had overshot the full employment mandate and needed to tighten policy more aggressively to contain inflationary pressures. But we are not there yet.
Bottom Line: Looks like the Fed knew what it was doing by signaling a rate hike in recent weeks. The earlier than expected rate hike should correspond to a bump up in this week’s “dots.” Some participants with two dots will switch to three, some with three to four. I expect the median rate hike projection of Fed participants will be four, which I translate into a baseline case this year of three with an option on four. The Fed will want to front load these hikes to stay ahead of the curve, which means March, June, and September if the data allows. Then December if needed. Data as of yet does not suggest a need by itself to step up the pace of hikes even more quickly. Watch the longer-run rate forecast. A rise in the end game dots would have much more hawkish implications than just a small acceleration in the near-term pace of hikes.
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