One of the crucial questions relating to the timing of the first Fed hike is how much slack is prevalent in the US labour market. While the unemployment rate has come down significantly over the past four years, the Fed has made it clear it still sees lots of slack in the labour market.
In this document, we look at indicators and arguments in favour of and against the current Fed view. The data is not conclusive but, given the Fed view, we believe the risk seems skewed towards a tighter job market than perceived by the Fed.
A falling participation rate, a high share of long-term unemployed and still plenty of part-time workers wanting a full-time job suggests there is still lots of slack in the labour market. However, a low short-term unemployment rate, the longer time taken to fill vacancies and a brighter consumer view on the labour market indicate that more tightening than meets the eye is taking place.
The risk to the Fed view is that part of the slack consists of marginalised workers that have less influence on wage formation. Our analysis supports recent literature suggesting the long-term unemployed are increasingly marginalised and hence that the slack may not be as high as the Fed believes.
The key indicator to watch over the coming quarters is wage growth as an indication of how much the US labour market is tightening. We think wage growth will rise gradually over the coming year and pave the way for the first rate hike in mid-2015. However, we see the risk as skewed towards an earlier hike and not a later hike as the market currently prices.
The US unemployment rate has been falling steadily since its peak at 10.0% in the autumn of 2009 and has now reached a level of 6.3%. However, the unemployment rate is still above the historical average and the 5.4% level that the Fed sees as the ‘natural unemployment rate’, also called NAIRU. Despite the improvements in the labour market, this is yet to be reflected in wage growth and the inflation rate, which remain quite low.
Arguments for plenty of slack in the US labour market
There are numerous signs of a US labour market that is far from returned to normality and many of these were stressed by Fed chairman Janet Yellen in her speech in Chicago on 31 March.
Part time employment: Currently, 7.5 million Americans are currently employed part time but want to work full time if the economic conditions would allow it. This is considerably higher than the 4.6 million figure in December 2007, just before the financial crisis kicked in.
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