U.S. gross domestic product growth is expected to come in at 2.3 per cent for 2015, a solid but unspectacular expansion. For many, the still-sluggish growth path should preclude an increase in interest rates when the Federal Reserve Open Market Committee meets next Wednesday.
Below the surface, however, there are trends suggesting that significant and potentially damaging inflation pressure is building and a rate hike is justified.
There are ample signs of tightening U.S labour market that could soon, at long last, result in significant wage growth throughout the U.S. economy. Initial jobless claims have fallen from a 450,000 weekly pace in early 2010 to 275,000. The top line unemployment rate of 5.4 per cent is down by almost 50 per cent relative to the financial crisis peak.
The top chart underscores the tightness in the labour market. The orange line is the ratio of U.S. hires to reported job openings and the grey line plots the average hourly earnings of non-supervisory employees.
The lines move in opposite directions under normal, non-financial crisis conditions. A declining hirings to openings ratio means employers have jobs available that they can't find people to fill, and this creates upward pressure on average wages.
For the past three years, wages have failed to climb despite the exceeding low hires to openings ratio. This dramatically increases the possibility that considerable wage growth is on the horizon for American workers.
The second reason the Fed may raise interest rates is that the on-again-off-again uncertainty on the timing of the first hike is more damaging than any actual 25 basis point hike of the Fed funds rate.
According to the Financial Times, emerging markets central bankers just want Fed chair Janet Yellen to get it over with: Julio Velarde, Peru's central bank governor, said most emerging markets wanted the Fed to raise rates as soon as possible. "The uncertainty about when the Fed hike will happen is causing more damage than the Fed hike will itself," he said during a visit to Seoul.
Conor Sen, a hedge fund manager with New River Investments, believes the U.S. economy is on the verge of a serious housing shortage and this provides the third source of support for a higher short term interest rates. Slightly higher interest rates would provide time (through lower consumer demand) to allow housing construction to catch up to potential demand.
Mr. Sen uses the data from the lower chart below to outline his theory.
"Single-family housing starts remain at depression levels – what happens if they normalize?" Mr. Sen writes. "[Shown] is single family housing starts as a percentage of the age 25-54 population. I submit to you that this will get to at least 1 per cent during this [economic] cycle … That would be 1.25 million single family starts, 65- to 70-per-cent higher than we've seen in recent months. What would that level of activity do to the unemployment and inflation rates?"
Of these three justifications for higher U.S. interest rates – wage inflation, a potential housing shortage and uncertainty – only uncertainty is an issue right now. Wages have not yet begun to surge and housing prices, while higher, do not yet pose severe affordability problems for most Americans. As a result, only 28 per cent of economists believe a rate hike is in the cards in September.
But it's also the case that almost 60 per cent of economists believe the Fed will raise rates by December, and a tight labour market and the potential for inflation will be the likely drivers at that time.
Follow Scott Barlow on Twitter @SBarlow_ROB.