Wednesday, December 11, 2019
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How low can unemployment go?
The Federal Reserve's final policy meeting of the decade concludes today.
The central bank will release its latest monetary policy decision at 2 p.m. ET and Fed Chair Jerome Powell will hold a press conference at 2:30pm ET. No changes to the Fed’s benchmark interest rate policy are expected. And as Brian Cheung notes, the central bank is likely to set a “high bar” for future changes in the target policy range, which currently sits at 1.5%-1.75%.
But along with its 2:00 p.m. ET announcement, the Fed will also release an updated edition of its Summary of Economic Projections (SEP). The SEP includes Fed forecasts for GDP, unemployment, inflation, and interest rates over the next one-, two-, and three-year periods, as well as over the longer term.
And while investors most closely will look for the Fed's interest rate forecasts included in its dot plot, staff projections on unemployment are worth paying close attention to this afternoon. Last week, the November jobs report showed the unemployment rate fell to 3.5%, matching the 50-year low first hit in September.
As of September, Fed officials estimated that NAIRU — the non-accelerating inflation rate of unemployment — stood at 4.4%. NAIRU is the unemployment rate below which it is expected inflation would begin rising and higher rates would be necessary. In other words, when unemployment falls below NAIRU, it would be expected that — all else equal — inflation and wages would increase and higher rates and economic growth would follow.
And yet as we’ve seen for some time now, the unemployment rate has consistently moved lower and inflation pressures have remained muted.
If we take a look back at the Fed’s SEP released in December during each of the last five years, a clear theme emerges when it comes to the labor market: the Fed has been too conservative in judging the health of the labor market. And they’ve been too conservative for years. It’s part of why Neil Dutta at Renaissance Macro said that if the Fed doesn’t lower its NAIRU estimate in today’s SEP they are “nuts.”
Earlier this year, Minneapolis Fed president Neel Kashkari said the Fed had “misread” the labor market given its history of NAIRU estimates that were too high. “It seems clear to me that we are not yet at maximum employment,” Kashkari said back in May. And with the labor market having averaged job gains of 205,000 over the last three months and wage gains having flattened out after accelerating to post-crisis highs in 2017 and’18, it seems we are still not at maximum employment.
Inflation, meanwhile, has consistently run below the Fed's 2% target. This has led to questions about the efficacy of the Phillips Curve, which purports to show the relationship between falling unemployment and rising wages, and has been declared by none other than Jay Powell to have but a "faint heartbeat."
In December 2014, when the Fed was a year out from its first interest rate increase since the crisis, the SEP estimated that longer-run NAIRU was between 5.2% and 5.5%. As of December 2014, the actual unemployment rate was 5.4%. A year later, the Fed's median NAIRU estimate was 4.9% and the actual unemployment rate stood at 5%.
By December 2016, the state of play had flipped and actual unemployment moved below longer run estimates of what would be required for the Fed to meet its objectives of 2% inflation and maximum employment. Since then, this dynamic has remained.
The Fed’s NAIRU estimate moved down to 4.8% in the final month of 2016 and the unemployment rate had dropped to 4.7%. In 2017, the Fed raised rates three times.
In December 2017, SEP estimates for NAIRU continued chasing actual unemployment lower, with longer run estimates of steady state unemployment sitting at 4.6% while actual unemployment hit 4.1%. By the end of 2018, with the Fed having raised rates seven times in 21 months, estimated long run unemployment had declined to 4.4% while the unemployment rate stood at 3.9%.
Expected tweaks from the Fed to its employment outlook, however, are modest.
Economists at Deutsche Bank think the Fed could tweak its NAIRU estimate by 0.1%, pushing its median longer run expected unemployment rate to 4.1% today from 4.2% in December. Economists at Wells Fargo don’t foresee any “meaningful adjustments” to the Fed’s unemployment estimates.
But as the Fed continues a year-long re-think of its policy framework, the role employment plays in shaping the Fed’s decisions could perhaps get a new emphasis.
By Myles Udland, reporter and co-anchor of The Final Round. Follow him @MylesUdland
What to watch today
Economy
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7 a.m. ET: MBA Mortgage Applications, week ended Dec. 6 (-9.2% prior)
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8:30 a.m. ET: CPI month-on-month, November (0.2% expected, 0.4% in October); CPI excluding Food and Energy month-on-month, November (0.2% expected, 0.2% in October); CPI year-on-year, November (2.0% expected, 1.8% in October)
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2 p.m. ET: Federal Open Market Committee interest rate decision
Earnings
Post-market
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4:05 p.m. ET: Lululemon (LULU) is expected to report adjusted earnings of 94 cents per share on $899.44 million in revenue
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Other notable report: American Eagle Outfitters (AEO)
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