Get While the Getting’s Good: A Fed Preparing for More Rate Hikes Will Eventually Slow Job Growth
Published: Wednesday, February 15, 2017 | Author:
Josh Wright, Chief Economist
Fed Chair Janet Yellen gave financial markets a nudge during her testimony before Congress over the last two days. With the U.S. economy more or less at full employment, the Fed is preparing to follow through with further rate hikes, which are likely to slow job growth down the road.
Yellen’s remarks caught the markets a little off balance. With turmoil in the Trump administration eroding hopes for a significant economic stimulus package in the near term, and some mixed signals in the January jobs report, the markets had been pricing in only a 25% chance of the Fed raising rates in March. They expected Yellen to affirm this view by striking a dovish tone and backing away from the 3 rate hikes projected by the Fed’s policy making committee for 2017. Instead, Yellen reiterated her recent phrases about how it would be “unwise” to wait too long before raising rates and how this will be up for discussion at “upcoming meetings.” The “unwise” comment is something we have heard before over the last two months, so the net effect was for Yellen to stand behind prior communications, rather than walk them back. Between that and some firm inflation data, the market has bumped up the probability of a March hike to about 40%.
That doesn’t necessarily mean Yellen intends to hike in March, but she probably thought that 25% probability assigned by the market was too low. Most likely, she has no set plan but wants more optionality to hike in March or shortly thereafter, if the latest data and the rapidly evolving policy outlook warrant. Why would she want such a free hand? It may be that she takes a more sanguine view of the latest jobs report than some other observers. Many commentators looked at the increase in labor force participation and the deceleration in wage growth and concluded that we are not at full employment after all, while others saw the pace of job gains as too fast relative to the low unemployment rate and current population growth. Yellen appears to be in the latter camp, which fears that eventually this dynamic could lead to an outbreak of inflation.
Although I’m usually skeptical of ulterior motives ascribed to the Fed – which is filled with dedicated and capable public servants – it is possible that another dynamic is at play as well. Chair Yellen might like to get on with another rate hike while the getting is still good. Time and again over the last several years, the Fed has seen its plans to raise rates and otherwise normalize policy be thwarted or delayed by some unforeseen period of market turbulence, yet at the moment, the markets seem to have readily absorbed the latest rate hike, signs of turmoil in Washington, and even some discussion of the Fed readjusting its plans for its large portfolio of securities. Such good fortune may not last long.
What does all this mean for the labor market? In the very near term, not too much. Yellen made clear that the Fed still plans to take a gradual approach to raising interest rates, and each hike is expected to take 6-12 months to feed through to the rest of the economy. The good times may roll on for a while yet, albeit before long they should be rolling a bit slower.