Will Weak Jobs Put Rate Hikes at Risk?

With the labor market slowing down, will the Federal Reserve raise interest rates at its next policy meeting in two weeks? That was the big question after the Labor Department reported that the economy added a disappointing 138,000 jobs in May, worse than the 185,000 analysts had expected. Additionally, the previous two months were revised lower by 66,000, putting the three month average at just 121,000. In the first five months of 2017, the economy has seen average monthly job creation of 162,000, down from 189,000 in 2016, and 226,000 in 2015.

The unemployment rate ticked down to 4.3 percent, the lowest level since May 2001. However, the rate slid because 429,000 workers left the labor force, rather than securing new jobs. The rate is now well below the Fed’s 4.7 percent estimate of its so-called “natural” rate, which is the rate at which any one who wants a job can get one. The broader measure of unemployment (“U-6), which tallies the unemployed, as well as those too discouraged to seek a job and part-time workers who would prefer to work full-time, fell to 8.4 percent, a level last seen in November 2007, a month before the recession started.before the recession started.

The labor force participation rate, which is the percentage of the population that is either working or actively seeking work, declined by 0.2 percentage points to 62.7 percent in May, perilously close to the forty-year low of 62.4 percent. The rate, which peaked at 67.3 percent in 2000 and was at 66 percent before the start of the Great Recession, is likely to remain historically low, due to the current composition of the U.S. population. According to analysts at Capital Economics, aging Baby Boomers will cause a rising retirement rate and an age-related increase in disability. Economists at the Federal Reserve project that these demographic trends will push the participation rate down by another 2 to 3 percentage points over the coming decade.

In addition to weak job creation and low participation, the May employment report also showed that average hourly earnings increased by just 2.5 percent from a year ago. While the May jobs report was weaker than expected, most economists believe that the central bank remains on course to increase short-term interest rates for the second time this year at the June meeting. However, the pace of hikes in the second-half of the year could slow, especially if economic data were to deteriorate and if lawmakers are unable to raise the federal debt limit and approve government funding for the year beginning October 1.