Atlanta Fed President Dennis Lockhart commented that the Fed is in a "real debate" on a rate hike in early to mid-2015. The economy has certainly shown resilience and it will not be surprising to see an interest rate hike soon. However, there are still some not so comforting factors related to unemployment and these factors will be in the policymaker's mind, before an interest rate hike decision is made. This article discusses these factors and discusses if they are big enough to prevent the Fed from increasing interest rates.
If we just consider the headline unemployment rate, the economic scenario seems to have improved significantly with headline employment declining to 6.2% in July 2014 from 10.0% in October 2009.
Unfortunately, the headline unemployment number is not the only factor to consider for understanding the real employment scenario in the economy.
There are other not so favourable factors listed below that can be a concern.
The people not in the labour force are at a record high of 92 million. This has increased from 79 million in October 2007. In my opinion, this is a big negative factor as it puts pressure on the working population, which is shrinking.
The civilian employment-population ratio is currently at 59% and this is still at a 30-year low. This supports the first argument that a small number of working population is supporting the economy and dependents. A per capita decline in consumption is inevitable in such a scenario.
Another supporting data that indicates the weakness in the economy is the civilian labour force participation rate (25 to 54 years). The participation rate has declined from 83.1% in January 2008 to 80.7% in July 2014. The concern is that the declining trend is still evident and if things get worse, it will further impact the consumption factor.
The U6 rate has declined from its peak of 17.2% and is currently at 12.2%. The number is still not comforting as it indicates that a large population is employed on a part-time basis for economic reasons. If there is any slump in the economy on tapering and interest rate hike, the headline employment can surge again.
The unemployment rate between 16-19 years and 20-24 years also remains high (relative to the headline unemployment rate) at 20.2% and 11.3% respectively. An ideal scenario would have been that these rates were equal or lower than the total unemployment rate. Dissatisfaction among the youth is also a crisis.
The average duration of unemployment is another number that remains stubbornly high and has a negative impact on consumption. The average duration of unemployment is currently at 32.4 weeks and this is still at very high levels as compared to the historical data since 1950. From 1950 to 2010, the average duration of unemployment was never above 20 weeks.
Therefore, the headline unemployment is insignificant in front of these numbers and these numbers suggest that the employment scenario is much worse than what headline unemployment shows.
I have not seen many articles or news that highlights the number of SNAP participants in the United States. The number of SNAP participants has increased from 27 million in December 2007 to 46 million in April 2014. Why would people need increasing food and nutrition support in an improving economy?
There are therefore unemployment factors that can continue to postpone the interest rate hike. It is another area of debate if low interest rates can help these factors improve. However, going by the mindset of policymakers, the interest rate hike decision will be difficult and the rate hike can be delayed to the end of 2015, if not further.
If all this is considered from an investment perspective, risky asset classes will continue to do well. However, as I discussed in one of my recent articles, I believe that equities are likely to correct by 10%-15% and investors will be better off in the sidelines. Investors can also consider switching to low beta stocks or treasury. My investment suggestion would be -
- Vanguard Long-Term Corporate Bond ETF (NASDAQ:VCLT) - This will give investors exposure to quality corporate bonds, which are a better option than Treasury bonds.
- Vanguard Short-Term Bond ETF (NYSEARCA:BSV) - This will give investors exposure to short-term government bonds, which can rally if the equity markets correct.
- The Procter & Gamble Company (NYSE:PG) - I like this low beta name. The company has also announced recently that it will divest its non-core brands and I believe this is a good move. I am positive on this stock in the near term and long term. PG also offers a healthy dividend yield of 3.2%.
There will be several attractive opportunities available in the stock markets if the markets do correct by 10%-15%. I will discuss these opportunities as and when the correction comes.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.