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May 13, 2015

Why The Fed Should Raise Rate Sooner Than Later

By Rick Rieder for BlackRock
The U.S. economy is once again underperforming expectations, as it has in the first quarter of the past five years. Yet despite the recent slowdown, the economy is ready for a Federal Reserve (Fed) interest rate hike.
Indeed, as my colleagues and I write in our new BlackRock Investment Institute paper, “When the Fed Yields,” “zero is the wrong number for short-term rates” today, because there are clear signs that the U.S. economy already exhibits much of what the Fed has said it wants to see on the jobs and inflation front before raising short-term interest rates.

Solid jobs growth

The BlackRock U.S. Employment Index—our gauge of 10 key labor market indicators—has risen back to pre-crisis levels. All of the index’s subcomponents have turned positive this year, as the chart below shows.

In addition, April’s payroll report reaffirmed the strong, and generally consistent, run in payroll growth that weak March figures had seemingly called into question. More jobs have been created over the past 24 months than over the 13 years previous to that combined. Jobs growth has been pretty steady (despite a March blip)—and given the April rebound in payrolls, it’s hard to see this trend changing any time soon. In fact, the last time that 12-month non-farm payrolls job growth was as strong as it is today, the early 2000s, the Fed’s policy rate stood near 6% (versus effectively zero today).
Additionally, while average hourly earnings (AHE) still appeared sluggish in April’s payroll report, there are other indicators of growing wage pressure. The recent strong Employment Cost Index report, alongside robust permanent and temporary hiring surveys, suggest that there is a significant lack of qualified workers for hire at this point, or in other words, that labor markets are tightening.

A trough in inflation

Falling oil prices and the strong U.S. dollar have dampened headline consumer price index (CPI) inflation, but the recent core CPI print suggests a clear firming in inflationary conditions. In addition, 10-year U.S. inflation expectations are now at the highest level since October, though still below last year’s level.
To be sure, the Fed’s preferred core inflation gauge—personal consumption expenditures (PCE)—stood at just 1.4% in March. This is well below the central bank’s 2% target. However, the Fed has said it doesn’t expect to see inflation hit its target before raising rates. The effects of an aging population and rapid technological innovation are suppressing inflation and nominal growth, and goods prices have been stagnant over the past five years, dragging overall inflation lower.
The above, coupled with stable markets and easy monetary policy elsewhere in the world (most notably in Europe and Japan), argues for raising the short-term rate sooner rather than later. April’s jobs report makes a case that the Fed’s initial policy rate hike should begin September, with a gradual pace of movement from there. Policy rate normalization should not only be borne well by the economy, but it may actually hold a positive impact.
The economy is likely to bounce back later this year, and it would be both disheartening and potentially destabilizing if the Fed were to squander this window of opportunity to make an initial rate move in 2015.
“Emergency” accommodation has overstayed its welcome, and keeping rates excessively accommodative almost certainly holds an increased risk for markets. The Fed’s highly accommodative monetary policy has inflated asset values across global markets. The longer the Fed leaves its target rate at zero, the greater the chance of asset price bubbles—and eventual crashes.
Sources: BlackRock research, BlackRock Investment Institute, U.S. Department of Labor Bureau of Labor Statistics  
About The Author: Rick Rieder, Managing Director, BlackRock’s Chief Investment Officer of Fundamental Fixed Income, is Co-head of Americas Fixed Income, and is a regular contributor to The BlackRock Blog.    
This material is contains information from publications prepared by the BlackRock Investment Institute and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of May 2015 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. 
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