Fed Rates Uncertainty Tied To Jobs Uncertainty

Federal Reserve officials took a small step toward raising short-term interest rates in 2015 by introducing language into their policy statement that asserted they would be patient about moving away from near-zero short-term interest rates.

Yet in doing so, the post meeting statement unmasked the concern central-bank officials’ feel about their next move and how to communicate it. It also showed the internal divisions being created inside the Fed by the prospect of interest-rate increases in the months ahead.

Why is this the case? Despite the Labor Department recently reporting 321,000 new hires last month and the U.S. economy on track for its strongest year of job creation in 15 years, the jobs market still lacks an edge. This is echoed in Federal Reserve Chairman Janet Yellen’s distain for the traditional unemployment rate, which currently at 5.8%, is at its lowest level since September 2008.

Though hiring was broad based last month including employers in: a) the Professional and Business Services category adding 86,000 jobs b) Retailing adding 50,000 jobs c) the health-care sector adding 29,000 positions and d) manufacturing adding 28,000 jobs, this only tells part of the story. It fails to account for the people who are either: a) involuntarily working part-time (when they really want to find a full time job) or b) those who have just given up looking for work. When you include both groups, the real unemployment rate almost doubles to 11.4%!

Additionally, Ms. Yellen has been very cautious about easing monetary stimulus without evidence of wage pressure. As a result, most financial experts believe that a Fed rate increase is several months away. This is the case because the Fed is weighing a mix of economic data. In addition to the job market, inflation is facing a new downdraft that officials said they were watching closely.

In forecasts released along with the statement, 15 of 17 officials said they expected to raise rates in the coming year. The median estimate among officials—meaning half of estimates were above and half below—put rates at 1.125% by the fourth quarter of 2015. They see a shallow path of increases once they start. The median rate estimate for 2016 was 2.5% and for 2017 3.625%.

Those estimates are all modestly lower than the Fed projected in September, meaning that even though officials continue to expect to move rates up next year, they see a mild approach once they start raising them. The estimates—though preliminary and subject to change—imply Fed officials have in mind four quarter-percentage point moves in 2015.

Behind the move toward rate increases is a growing conviction the U.S. economy is on a stronger path, even as the rest of the world struggles with low or slowing growth. Fed officials projected the domestic economy would grow at a rate between 2.6% and 3% in 2015 and that the unemployment rate would fall to 5.2% or 5.3%.

That would put the jobless rate in a zone officials call “full employment,” in which joblessness is low but not so low that it sparks inflation.

Recent economic data did little to dissuade Fed officials from this view.

“Labor market conditions improved further, with solid job gains and a lower unemployment rate,” the policy statement said.

Yet there are several wild cards that could alter the Fed’s course. The most obvious is the path of inflation. Tumbling oil prices are pushing down consumer price inflation. The Labor Department reported Wednesday, hours before the Fed statement was released, that consumer prices dropped 0.3% in November from a month earlier, the largest one month drop since the 2008 financial crisis rocked the global economy.

Fed officials are sticking to their view that the downward pressure on inflation will be sharp but short-lived. Officials projected 1.0% to 1.6% consumer price inflation in 2015, a large downward revision from earlier estimates. But they saw it returning to between 1.7% and 2.0% in 2016 and between 1.8% and 2.0% in 2017.

Those longer-run forecasts suggest the Fed has confidence that recent oil declines won’t seriously derail their efforts to get inflation back to the 2% goal. It has been running under that goal for nearly three years but many officials believe that as labor market slack diminishes, inflation will move back toward 2%.

“The committee continues to monitor inflation developments closely,” the statement said.

What are your thoughts?