The Federal Reserve has signaled a strong likelihood that it will raise interest rates next year. The guiding star for the Fed: the labor market recovery.
The central bank has held short-term interest rates at near zero since the depths of the pandemic, a way of stimulating economic activity by transmitting lower borrowing costs.
But rising inflationary pressures have convinced the Fed that the time to raise rates may be coming soon. All of the 18 members of the policy-setting Federal Open Market Committee now project at least one 25-basis point rate hike before the end of 2022.
Fed Chairman Jerome Powell said Wednesday that the Fed will know it is time to raise rates when the central bank feels it has achieved “maximum employment” in the labor market.
“That it is admittedly a judgment call because it's a range of factors — unlike inflation, where we have one number that sort of dominates. It's a broad range of things,” Powell said Wednesday.
Powell pointed to other labor market measures like job openings, the quits rate, and labor force participation. The Fed’s approach to measuring labor market conditions has evolved under the Powell-led Fed, which has de-emphasized the historic focus on the headline unemployment rate.
The Fed chairman even nodded to the Employment Cost Index, a measure of total employee compensation that has reflected notable increases in compensation and wages this year. Total compensation rose by 4.1% in the third quarter of the year, with those in the lower-paying leisure and hospitality industry seeing even more compensation increases (6.9% in the quarter).
Skanda Amarnath, executive director at Employ America, said he is encouraged by the Fed’s willingness to look at many labor market measures.
“That’s a good sign, that [Powell’s] actually going to look at a holistic view of labor markets that involves wage growth,” Amarnath told Yahoo Finance. “I think that’s a really positive change from the previous decade of Fed policy saying ‘well, unemployment’s low so I guess we’re at maximum employment.’”
Defining ‘maximum employment’
For the Fed, looking at a dashboard of labor market indicators will require discretion in assessing “maximum employment.”
Right now, for example, the labor force participation rate (the percentage of the population employed or actively searching for work) remains at 61.8%, struggling to get close to the pre-pandemic figure of 63.3%.
However, prime-age labor force participation (which zones in on those between 24 and 54 years of age), is at 81.8% — with signs that it can continue to rebound to the pre-pandemic rate of 82.9%.
Deviations in these types of readings may cloud Fed officials’ assessments of the labor market recovery, especially in lieu of questions over whether or not the pandemic permanently impacted the pool of available workers.
As Powell said, it will be a “judgment call” for Fed officials as to when labor market readings, on the whole, signal that it is ready to handle higher interest rates.
“The Fed can declare victory on full employment at any time now,” said Tim Duy, an economist at SGH Marco Advisors. “It is just a matter of pulling together the consensus.”
That “judgment call” will not be the end all for the labor market recovery; Fed officials have made it clear that even after the initial rate increases, labor conditions can continue to improve.
“We would certainly not, in any way, want to foreclose the idea that the labor market can get even better [after declaring maximum employment],” Powell said Wednesday.
Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.
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