June 2, 2017 / 8:44 PM / 2 years ago

COLUMN-Fed may carry on with hikes even as job growth tapers: James Saft

(The opinions expressed here are those of the author, a columnist for Reuters)

By James Saft

June 2 (Reuters) - Employment growth may be slowing, potentially signaling a rising risk of a recession, but the Federal Reserve has tactical reasons to forge ahead with interest rate rises.

That’s because the Fed, with interest rates at still very low levels, faces asymmetric pressure to get more room between current rates and the zero lower bound, basis points which can serve as ammunition when and if a downturn materializes.

Job creation slowed in the U.S. last month to 138,000, more than 20 percent below the 12-month average and well below expectations. Revisions trimmed 66,000 from the previous two months’ totals, taking the three-month average to 121,000, down a third from its former pace.

Blips like this are not unknown in ongoing expansions, and it is too early to get alarmed over a near-term downturn. Even though flagging job creation would remove the single leg of the Fed’s one-legged justification for tightening, don’t expect the U.S. central bank to be quick to back away from its expected two rates hikes this year, one of them on June 14.

Yet if the long-running U.S. expansion was heading towards a recession, this is about how it would begin.

“Slower employment growth always begs the question of recession risks. In our view, employment growth is one of the stronger recessionary indicators, and slower employment growth is something we always take seriously. In past cycles, slower employment growth (relative to the recovery-level average) has preceded recessions by 9-12 months, and we would take it as a negative signal should employment growth continue to soften,” Barclays economist Michael Gapen wrote to clients after the data.

This could be seasonal effects, or the ebbing of what Gapen calls “post-election euphoria”.

The data offered nothing by way of assurance that inflation will pick up soon, with average hourly earnings up just 2.5 percent year-on-year despite the lowest unemployment in 17 years. By the Fed’s preferred measure, inflation is just 1.7 percent, and heading in the wrong direction away from the 2 percent target.

If the job creation trend continues downward and inflation simply remains where it is, the Fed would normally respond by signaling a willingness to slow its expected pace of increases. If inflation isn’t rising sufficiently and jobs are only being created at slightly more than the rate needed to keep pace with population growth, then the justification for carrying on with rate rises past June, much less beginning to trim the balance sheet, looks shaky.

Remember too that the unemployment rate fell this month mostly because the labor force shrank.


Fed governor Lael Brainard, in a May 30 speech, acknowledged the contrast.

“I see some tension between signs that the economy is in the neighborhood of full employment and indications that the tentative progress we had seen on inflation may be slowing,” Brainard said. “If the tension between the progress on employment and the lack of progress on inflation persists, it may lead me to reassess the expected path of the federal funds rate in the future, although it is premature to make that call today.”

It is probably still premature to make that call, and you’ll have to look elsewhere in Brainard’s speech to understand why.

“Attaining the Committee’s symmetric target for inflation on a sustainable basis is especially important in the current environment, with the neutral real interest rate at historically lower levels, in order to ensure conventional policy has room to respond to unexpected adverse developments,” Brainard said.

In other words, while stressing that the important thing is to get inflation where the Fed wants it, she is acknowledging that this is in substantial part important now because that goes hand-in-hand with raising interest rates.

Brainard went on to explain that part of the benefit of keeping the balance sheet at a steady size even as unemployment dropped and dropped was that this enabled the “federal funds rate to rise more quickly than would have been possible with a shrinking balance sheet and sooner reach a level that allows for reductions if conditions deteriorate.”

And with two more hikes taking the fed funds rate almost halfway to the long-run 3 percent neutral rate, Brainard seems to look forward to being able to declare victory and go home.

One distinct possibility is that even if job creation continues to flag, the rate is hiked twice more this year and the next move afterwards is a cut, perhaps without the balance sheet ever beginning to taper. (Editing by James Dalgleish) )

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