IHS Markit Predicts One More Fed Rate Rise This Cycle

by: Tim Worstall

IHS Markit expects just the one more interest rate rise from the Federal Reserve this year.

Inflation is expected to rise to target and growth to moderate to trend.

The wobbly here is what happens to the employment numbers and the unemployment rate.

IHS Markit is, of course, only one of the many people trying to predict the monetary policy cycle in the near future. Their forecast is that the Federal Reserve will have just the one interest rate rise late this year and then that will be it for the cycle.

Inflation is expected to rise to target, allowing that rate rise. But growth to moderate back to trend levels meaning no greater rise is necessary. From their report:

United States Federal Reserve

Expected monetary actions during the next two years:

Muted inflation and few signs of significant fiscal imbalances provide the Fed with an opportunity to be patient as it awaits further information. The late-2019 rate hike is expected to be the final rate hike for this tightening cycle. The Federal Open Market Committee (FOMC) has yet to decide important issues related to the evolution of the maturity composition of the Fed's Treasury holdings and whether to accelerate shrinkage in its mortgage-backed securities (MBS) portfolio (offset by reinvestment in Treasuries).

Impact on growth and inflation:

We project real GDP growth will slow in 2019 to roughly a trend pace, and inflation will firm to above 2%. These projections are consistent with one more Fed rate hike in late 2019, which would raise the upper end of the target range for the federal funds rate to 2.75%. Such a move can be viewed as maintaining the real federal funds rate near 0.5% as inflation firms to slightly above 2%.

The big question(s) is around what might change that view? There being two major points to consider.

The first is that desire to have greater room for monetary relaxation come the next recession. We don't believe that we've beaten the business cycle, there is going to be another downturn. So, it's a standard desire of central bankers to have interest rates up high enough that they can be cut as and when one turns up.

Conflicting with this is the aim of not causing a recession by inadvertently raising interest rates too high. The implication of this being that if we are to look at general economic conditions then yes, matters might well work out as IHS have it. But if the Fed wants to have that greater firepower in reserve then we might either gain earlier rate rises or more. Our unfortunate position being that we'll only know what the Fed thinks when they do it.

The other issue is something we touched upon briefly here, when looking at the ADP employment numbers. Higher employment numbers are great, more people in work, what's not to like? Well, as I explained:

What has rather surprised is that this isn't true. Month by month we expand employment. The unemployment rate doesn't move very much. What's happening is that people we thought were entirely out of the workforce are coming back into it. For those who prefer technical terms U3 is not changing much, U6 and beyond are falling, which is what explains how we can increase employment numbers.

The problem for us all as prognosticators is that we're in unknown territory here. The general economist's view is that we should already be seeing substantial wage inflation pressures. We're not. Or rather, the general economists' view was that if we got to here we would be, we're not and no one is quite sure why. And if the professional economists don't know then we're in a pickle as well.

The general bet is that at some point this process will stop. We will have pulled back into the labor force everyone who will or can be. At which point any further increase in demand for labor will just turn up as that inflationary pressure on wages, which will then feed through into general inflation.

At which point, what happens? The Fed raises interest rates and chokes off that economic growth. And don't forget that other than this last one from the housing crash near all post-war US recessions have been caused by the Fed tightening monetary conditions to try to choke off inflation.

When might this process stop? An indicator at least is when we do indeed have better employment numbers but these are accompanied by a lower unemployment rate. That would mean that we weren't continuing to pull people in from outside the formal labor market. We really are at full employment and thus further increases in labor demand will just feed through into wages and thus inflation. At which point the Fed really does think about choking off the expansion.

From the more formal employment numbers:

The unemployment rate declined by 0.2 percentage point to 3.6 percent in April, the lowest rate since December 1969. Over the month, the number of unemployed persons decreased by 387,000 to 5.8 million....

The labor force participation rate declined by 0.2 percentage point to 62.8 percent in April but was unchanged from a year earlier. The employment-population ratio was unchanged at 60.6 percent in April and has been either 60.6 percent or 60.7 percent since October 2018....

Total nonfarm payroll employment increased by 263,000 in April, compared with an average monthly gain of 213,000 over the prior 12 months.

We've got a decent increase in employment. But not a similarly decent increase in pulling the economically non-active into the labor force or employment. Thus the unemployment rate fell - recall, the unemployment rate (or at least this one, U3) is counting only those actively looking and presenting themselves for a job - and that's the process which could well be the trigger for more Fed rate rises.

We should never - well, at least not unless we start seeing truly extraordinary figures - place too much weight on just the one month's numbers. So this is more of a trend to keep an eye upon than an alarm bell right now. But it really is true that what causes the Fed to end expansions though interest rate rises is when labor demand starts showing up only as inflation causing wage increases rather than pulling ever more people into the formal labor market. So, when we start seeing the unemployment rate dropping as a result of higher employment numbers then we've got to be wary of the Fed doing exactly that, tightening monetary conditions through more interest rate rises.

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