The unemployment rate dropped to 6.6% in January, making good progress, but even with this major hurdle behind us, the Fed still faces three major challenges before the “maximum employment” mandate is met.
- Residual unemployment. 3 million workers will have to find jobs for the unemployment rate to fully return to its normal rate—and many of those currently unemployed have been out of work for over six months, which means this is a serious obstacle to watch. A strengthening economy will bring that number down, but additional challenges remain.
- Insufficient full-time jobs. There are 3 million part-time workers currently searching for full-time positions, and these workers constitute a significant reserve of labor supply not counted in the official unemployment rate.
- Renewed job searches. At least 3 million 16- to 35-year olds abandoned their job search during the recession. As they emerge and resume seeking work, their numbers will at least temporarily buoy the ranks of the officially unemployed.
While the unemployment rate remains the single most useful measure of economic health, it doesn’t reflect other significant headwinds that are shaping the Federal Reserve’s interest rate policies. The labor market needs to make a robust recovery and largely eliminate these hidden sources of slack before the Federal Reserve will begin normalizing the overnight interest rate.
What does the overnight interest rate increase mean for business? The immediate effect will likely be confined to a nearly instantaneous step up in the prime rate. A broad range of credit products, such as mortgages, auto loans, and consumer credit will follow with a gradual rate increase.
In this case, however, when the overnight rate is hiked, the market’s response should be muted. Investors already anticipate interest rates will start rising next year, and this shift is priced into the market, making a repeat of last summer’s abrupt reaction to the taper’s announcement unlikely.