Last Friday’s payrolls saw the US unemployment rate fall to 5.9%, within striking distance of the Fed’s estimate of the NAIRU of 5.2% to 5.4%.
- Given that unemployment is falling at about 0.1% percentage points per month, the NAIRU, where the Fed expects inflation to start accelerating, may be reached early in 2015.
- The September Survey of Economic Projections envisaged the first hike coming in mid-2015, but with end-year unemployment in the 5.4% to 5.6% range (i.e. they planned to hike before hitting NAIRU). We could be at those levels very early in 2015.
- The bottom line is we are using up slack faster than the Fed expected. This risks an earlier and steeper rate hike cycle than the market has priced in.
- There will be an intense debate at the October FOMC about language and about when the first hike should be. If the Fed is truly as data dependent as it says, the risk scenario is of an earlier hike than most think.
- The market wants to see higher inflation before it buys fully into Fed rate hikes, but the Fed is watching the precursors of inflation, chief amongst them slack in the jobs market, which is why last week’s number was so important.
- The last hiking cycle kicked off when the unemployment rate was 5.6%. It allowed expansion to continue and did not rile markets. Some on the FOMC will argue to follow this. The main arguments against are weak commodities and a strong USD.
