The US economy has shrugged off a poor first quarter and is now posting some of its strongest job gains in the past eight years. If maintained, the jobs market is set to post its best year since 1999. Under those circumstance I don’t see how the Federal Reserve can justify keeping rates at zero until well into 2015.
Non-farm payrolls rose by 288,000 in June, beating market expectations, following solid gains since February. Job creation in May was revised up to 224,000 (from 217,000). This was the fifth consecutive month that non-farm payrolls rose by over 200,000 and the last five months has seen the strongest gains in employment in around eight years.
Private non-farm payrolls rose by 262,000 in June, while government payrolls were up by 26,000. That was driven by local government, who over the past five months have increased payrolls by 76,000. Government payrolls -- at all levels -- still remain well below their peak.
Jobs in service industries expanded by 262,000, while payrolls for the goods sector rose by a more modest 26,000. Over the past year the service industry has accounted for almost 88 per cent of jobs growth, which is broadly in line with its medium-term trend.
The unemployment rate dropped to 6.1 per cent in June -- its lowest level since September 2008 00 to be 1.4 percentage points lower over the year. About half of the decline is due to a fall in the participation rate -- though it was unchanged in June -- which partially reflected an ageing population but also some Americans giving up on finding work after a lengthy period of unemployment.
The participation rate is expected to trend lower over the next decade as the ‘baby boomers’ retire. However, I wouldn’t be surprised if it ticked up temporarily as conditions in the US economy improve. That might be sufficient to encourage some Americans to re-enter the workforce, although based on prior research, the long-term unemployed will find the going fairly tough even during the good times.
With millions of discouraged workers waiting for an opportunity, there remains considerable spare capacity across the US economy. The labour market is certainty not as tight as the unemployment rate of 6.1 per cent suggests.
Nevertheless, that spare capacity is being reduced and at a relatively fast pace over the past year. Inflation has picked up towards the upper band according to a range of measures and the Federal Reserve’s preferred measure, the core personal consumption expenditure deflator, has also picked up recently.
With the unemployment rate set to fall below 6 per cent in the coming months, it is difficult to see how the Fed will justify keeping rates at the zero lower bound. In that situation, the level of monetary accommodation provided by the Fed would be simply extraordinary and completely out of whack with what is normal when the unemployment rate is around 6 per cent.
The Fed’s current plan is to wait until well into 2015 before it considers raising rates. But surely that timetable will be brought forward somewhat if non-farm payrolls continue to expand at their current rate. If that was to eventuate then payrolls could post their biggest annual gain since 1999 and extraordinary monetary stimulus would no longer be warranted.
The Fed is all but certain to wind back its asset purchases by a further $US10 billion when they meet at the end of July. But it should give serious consideration to also adjusting its communication, preparing markets for the possibility that rates may rise a little earlier than expected.