Is it Time for the Fed to Raise Rates?
The latest numbers from the Bureau of Labor Statistics put the number of new jobs in July at 255,000 after a great June increase of 292,000 new jobs. We have now reached the 70th consecutive month of positive job growth in the United States. The last time we saw an overall loss in job growth was in 2010. Unemployment is below historical averages and it seems natural to ask if the Fed should go ahead and start raising rates. Here are a few reasons why they should still wait.
The first is that while unemployment is low, participation rates are still low as well. During the recession, the United States saw an incredible amount of its citizens fall out of the workforce and never come back. The unemployment rate only includes those who are looking for a job and does not include these “lost” workers. However, we are finally seeing the participation rate increase in the U.S. and it could be a mistake to tighten before more workers have re-entered the workforce. An increase could slow down the amount of jobs created right as many are trying to come back into the workforce.
The second reason is that even a small increase in rates could cause some large reverberations in the still fragile capital markets. A rise in rates would cause more inflows into the United States causing the dollar to rise even further. This will put a downward pressure on exports and overall growth at a time where growth is still too low for comfort. Additionally, capital is already having trouble reaching some parts of the world and there is already a surplus here in the United States which could leave parts of the emerging markets susceptible to a liquidity crisis.
The third and final reason might be the most crucial. Inflation is still too low to justify an increase in interest rates. Inflation has stayed stubbornly low and PCE inflation is still only around 1% over the last year. This is much lower than the Fed’s stated 2% target. What is more, the market is pricing inflation to be much closer to 1% over the next five years. With rates already so low, the Fed’s ability to fight deflation is already seriously compromised and a rise in rates could push inflation even lower.
While unemployment numbers are encouraging, the economy overall is still too fragile to risk an increase in rates especially when looking at the rest of the globe. The U.S. remains the only stable economy in the world and even a small shudder in growth could have a significant impact on the global economy. The Fed feels like it needs to “normalize” rates as quickly as they can but hopefully they will be cautious in reacting too quickly.