During a Senate hearing this week, Jerome Powell was asked about the balance between the Fed’s dual mandate of price stability and maximum employment.
Powell said: “Right now the labor market is extremely tight and I would say unsustainably hot. And there is a mismatch between supply and demand there.
I’ve used this table before, but it deserves to be reposted:
There are two jobs available in this country for every person who is unemployed and looking for work.
I would say that constitutes a mismatch between supply and demand.
We’ve never seen anything like it, so Powell’s description of the labor market as unsustainably hot makes sense.
The fact that the labor market is so hot is one of the main reasons the Fed pays so much attention to the price stability component of its dual mandate.
By raising interest rates, the Fed hopes to slow demand but also cool the labor market to temper inflation.
Former Treasury Secretary Larry Summers said this week that the unemployment rate needed to be above 5% to contain inflation:
We need five years of unemployment above 5% to contain inflation – in other words, we need two years of unemployment at 7.5% or five years of unemployment at 6% or a year of unemployment at 10%.
I’m sure Summers uses some sort of economic formula to get to this level, but all you have to do is look at history to see what happens when the unemployment rate goes up.
Here is the unemployment rate dating back to the late 1940s:
When the unemployment rate bottoms out, it always goes much higher. This makes sense considering that these spikes are caused by a recession in any case.
Here are the lows and highs of each cycle:
The lowest unemployment rate in modern times was 2.5% in the early 1950s. This is also the lowest unemployment rate ever recorded after a recession at 6.1%.
The average increase in the unemployment rate is over 4%. On average, the unemployment rate doubles when it rises during an economic downturn.
Although the unemployment rate has not yet started to rise, all sorts of other rates have already risen.
Everyone already knows that the inflation rate has skyrocketed, but that also pushes bond yields up. The only other time inflation was as high as 10-year Treasury yields was in the mid-1970s:
In fact, from 1981 to 2005, the rate of inflation never exceeded US government bond yields.
What you need to understand about interest rates is that while they generally move in the same direction, they don’t move by the same magnitude.
Last week, Michael plotted the one-year rate change on the Treasury yield curve:
Bonds of 1 month to 3 years have seen increases significantly higher than yields of 20 or 30 years.
Unfortunately for debt consumers, interest rates on loans are also rising much faster.
The 30-year fixed rate mortgage tends to track the 10-year Treasury yield quite closely:
This is good for future bond yields, but bad for current borrowers.
This is especially true of credit card borrowers. Look at how these rates have skyrocketed:
The good news is that many borrowers have taken advantage of the pandemic to pay off their credit card debt. Total US credit card debt is still lower than it was before the pandemic:
The bad news is that those who still hold that debt and don’t pay off their balance every month are now going to be in trouble.
Compare credit card rates that jump from 16% and jump to over 20% in the blink of an eye with the average return on savings accounts at traditional banks:
You may have to squint to see it.
Seven base points!
Obviously, you can make more money in an online savings account, but these rates aren’t very attractive yet. I use Marcus and they finally increased their returns to 1% this week.
It’s funny how quickly banks are raising borrowing rates for things like mortgages and credit cards, but moving at a lazy pace when adjusting savings account yields.
Michael and I talked about all of these rates and more in this week’s Animal Spirits video:
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Interest rates are getting weird
Here’s what I’ve read lately:
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