Employment data out of the US late last week highlighted a key point often missed when looking at the future of US interest rates. The Fed’s job is to maximise employment without letting inflation exceed their 2% target rate. The Fed doesn’t just monitor the number of people in jobs however, they also monitor underemployment
Underemployment means that someone has accepted a job with less hours or less pay than they are capable of, typically because of tough economic conditions.
Underemployment can be measured by two key metrics:
1. Wages growth– if the average person’s wages is growing slowly, it is an indication that the economy is failing to grow fast enough to use up all of the people available to work, i.e. it is below capacity and needs more stimulus.
2. U-6 Unemployment Rate– U-3 is the headline unemployment rate and is currently 5.3%, well below long-term averages. U-6 measures anyone out of a job and looking (U-3) plus those that have accepted less hours or less pay but are still looking for something better. The Fed pays particularly close attention to the gap between U-3 and U-6 as it indicates the “slack” in the economy, much like wages growth does.
Last week’s “Employment Cost Index” data measures the average wage growth. It was just 0.2% growth for the quarter, the slowest rate of growth in 27 years. This will reduce the likelihood of the Fed increasing interest rates. Markets reacted by cutting interest rates right across the yield curve, particularly the five year bonds which had risen sharply earlier in the week.
As the chart below demonstrates, the gap between the U-3 and U-6 is also pushing the Fed away from raising rates. The gap is still very high, with the U-6 measure still above its highest point prior to the 2008 GFC.
Until we see wages growth rising at or near the Fed’s target inflation rate of 2.0%, the Fed will be very subdued in its interest rate increases. Markets are slow to realise this, leaving good buying opportunities for long-dated bonds.
The graph depicts US unemployment rates including two measures: the headline rate and the metric that include underemployment. It also shows the gap between the two measures.
Source: Fed, FIIG Securities