SEP 09.11.2015

ECONOMICS: US PERSPECTIVES THE FED AND RATES: “WHEN YOU COME TO A FORK IN THE ROAD, TAKE IT”

+ Joseph G. Carson, US Economist and Director—Global Economic Research, [email protected]

Display 1 Policymakers have laid out a path that leads to the start of policy- Policy Accommodation Has Remained rate normalization in the US. Now, data indicating substantial and in Place Longer Than Expected sustained labor market gains are signaling that its time to raise rates. Job Openings vs. Fed Funds Target Rate Will policymakers instead choose a different path? We don’t think so. 6,000 8

5,500 7 Job Openings (Left Scale) 5,000 6

4,500 5 Percent Strong Underlying Labor Market Trends Current Fed Chair Janet Yellen stated in a 4,000 4

US labor market data are unambiguously March 2013 speech that “Federal Reserve Thousands 3,500 3 solid. Payroll employment rose by 173,000 research concludes that the unemployment 3,000 2 Fed Funds jobs in August, which is a little below rate is probably the best single indicator of 2,500 1 Target Rate trend. But the prior two months were current labor market conditions. In 2,000 0 revised up by 44,000 combined, and June addition, it is a good predictor of future 01 03 05 07 09 11 13 15 and July now show monthly gains of labor market developments. Since 1978, 245,000 jobs each. As a result, the three- periods during which the unemployment Through July 31, 2015 Source: Haver Analytics, US Bureau of Labor Statistics, month trend of 221,000 payroll jobs rate declined by one half percentage point US Federal Reserve Board and AB gained through August isn’t far off from or more over two quarters were followed the 12-month average of 240,000. by further declines over the subsequent two quarters about 75% of the time.” Other labor market indicators paint a picture of underlying strength. For Labor Improvement Has Cleared Every was projected at no more than one-half example, the number of job openings rose Hurdle percentage point above the FOMC’s 2% by over 400,000 in July, reaching a new Now comes the hard part: linking research longer-run goal, and longer-term inflation record of 5.75 million. This trend indicates to policy decisions. Policymakers have expectations remained well anchored. that the need for labor is rising even as the argued for a long time that the initial Since that time, policymakers have pool of workers is shrinking—most evident decision to lift official rates has always continued to change the criteria, and in the jobless rate declining by 0.2% to depended on sustained, substantial official rates remain exceptionally low 5.1%. That’s the lowest monthly jobless improvement in labor markets. despite major improvements in all these rate in over seven years. In fact, in the FOMC statement of areas. Clearly, they’ve let their experiment More “Wait and See” from Policymakers December 12, 2012, policymakers of using monetary policy to achieve labor As a group, policymakers want to see more explicitly connected the federal funds rate market gains run much farther than we’ve data on labor market trends before they and unemployment rate. They decided to expected (Display 1)—and farther than we decide on a path at the September 16–17 keep the fed funds range near zero, and predicted in past years. Now, with the Federal Open Market Committee (FOMC) said that such a low level would be jobless rate providing irrefutable evidence meeting, but it’s hard to see how the appropriate as least as long as the of labor market tightness, with near-record results could have surprised them. unemployment rate remained above 6.5%, numbers of small businesses saying they inflation between one and two years ahead can’t fill job positions and with additional 1 support from recent wage data, to do that now for some time. I’ve been policymakers seem to have run out of doing my best to make good on that Display 2 reasons and excuses for keeping official pledge.” Policy Normalization Needed to rates near zero. Sustain Business Cycle The Bottom Line: Running Out of Reasons New Arguments to Hold Off on Rate Hikes to Stand Pat Nominal GDP vs. Fed Funds Target Rate Despite the compelling evidence that In our view, the trends in employment, the 10 9 Financial Imbalance argues for beginning interest-rate hikes, jobless rate and even wages confirm the 8 8 GDP global policymakers, analysts and the script the FOMC was looking for in order 7 (Left Scale) 6 press have raised a number of reasons in to justify the start of rate normalization. 6 Percent recent days for delaying a Fed rate hike. The recent discussion in the financial press 4 5

The basic argument: the Fed hasn’t plainly of the potential impact of a 25-basis-point 2 4 telegraphed to financial markets that it will hike in the federal funds rate could seem 3 0 lift official rates; given the turmoil in reminiscent of the rumors and fears that Change Percent YoY Fed Funds 2 Target Rate (2) emerging markets, it would be better to dominated economic, financial and policy 1 hold off for now. discussions surrounding the Y2K issue. (4) 0 90 93 96 99 02 05 08 11 14 Yellen addressed both issues at a June In the final analysis, the only antidote to press conference, stating that “With fears and rumors is facts and reality. The Through June 30, 2015 Source: Haver Analytics, US Federal Reserve Board respect to international spillovers, this is US economy is on a solid foundation— and AB something that we have been long policy normalization is needed (Display 2), attentive to. Obviously, we have to put in and it should start at the next FOMC place a policy that is appropriate to meeting. evolving conditions in the US economy, but imbalances do develop when policy rates Policymakers also shouldn’t lose sight of we can’t promise that there will not be remain below the nominal gross domestic the key feature of policy normalization: volatility when we make a decision to raise product (GDP) growth path for an lifting rates gradually to fair value or rates. What we can do is to do our very extended period. So, the normalization of equilibrium levels will help sustain the best to communicate clearly about our policy rates isn’t meant to deal a blow to cycle and help alleviate or unwind financial policy and our expectations to avoid any the economic expansion, or to slow or imbalances that could threaten the cycle type of needless misunderstanding of our reverse gains in the labor markets. It’s further down the road—as happened in the policy that could create volatility in the meant to sustain the gains and extend the late 1990s and late 2000s. market and potential spillovers as well to cycle.n emerging markets, and I have been trying The historical record shows that financial

2 The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circum- stances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. Note to Canadian Readers: AllianceBernstein provides its investment management services in Canada through its affiliates Sanford C. Bernstein & Co., LLC and AllianceBernstein Canada, Inc. Note to European Readers: This information is issued by AllianceBernstein Limited, 50 Berkeley Street, London W1J 8HA. Registered in England, No. 2551144. AllianceBernstein Limited is authorised and regulated in the UK by the Financial Conduct Authority (FCA). Note to Austrian and German Readers: This information is issued in Germany and Austria by AB Europe GmbH. Local paying and information agents: Austria—Uni- Credit Bank, Austria AG, Schottengasse 6-8, 1010 Vienna; Germany:—BHF-Bank Aktiengesellschaft, Bockenheimer Landstrasse 10, 60323 Frankfurt am Main. Note to Swiss Readers: This document is issued by AllianceBernstein Schweiz AG, Zurich, a company registered in Switzerland under company number CHE- 306.220.501. AllianceBernstein Schweiz AG is authorised and regulated in Switzerland by the Swiss Financial Market Supervisory Authority (FINMA) as a distributor of collective investment schemes. This document is directed at Qualified Investors only. Swiss Representative & Swiss Paying Agent: BNP Paribas Securities Services, , Succursale de Zürich. Registered office: Selnaustrasse 16, 8002 Zürich, Switzerland, which is also the place of performance and the place of jurisdiction for any litigation in relation to the distribution of shares in Switzerland. Note to Australian Readers: This document has been issued by AllianceBernstein Limited (ABN 53 095 022 718 and AFSL 230698). Information in this document is only intended for persons that qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia), and should not be construed as advice. Note to Readers: This document has been issued by AllianceBernstein New Zealand Limited (AK 980088, FSP17141). Information in this document is only intended for persons who qualify as “wholesale clients,” as defined by the Financial Advisers Act 2008 (New Zealand), and should not be construed as advice. Note to Readers in Vietnam, the Philippines, Brunei, , , China, Taiwan and India: This document is provided solely for the informational purposes of institutional investors and is not investment advice, nor is it intended to be an offer or solicitation, and does not pertain to the specific investment objectives, financial situation or particular needs of any person to whom it is sent. This document is not an advertisement and is not intended for public use or additional distribution. AllianceBernstein is not licensed to, and does not purport to, conduct any business or offer any services in any of the above countries. Note to Readers in : Nothing in this document should be construed as an invitation or offer to subscribe to or purchase any securities, nor is it an offering of fund management services, advice, analysis or a report concerning securities. AllianceBernstein is not licensed to, and does not purport to, conduct any business or offer any services in Malaysia. Without prejudice to the generality of the foregoing, AllianceBernstein does not hold a capital markets services license under the Capital Markets & Services Act 2007 of Malaysia, and does not, nor does it purport to, deal in securities, trade in futures contracts, manage funds, offer corporate finance or investment advice, or provide financial planning services in Malaysia. Note to Readers: This document has been issued by AllianceBernstein (Singapore) Ltd. (“ABSL”, Company Registration No. 199703364C). ABSL is a holder of a Capital Markets Services Licence issued by the Monetary Authority of Singapore to conduct regulated activity in fund management and dealing in securities. AllianceBernstein (Luxembourg) S.à r.l. is the management company of the portfolio and has appointed ABSL as its agent for service of process and as its Singapore representative. Note to Taiwan Readers: AllianceBernstein L.P. does not provide investment advice or portfolio-management services or deal in securities in Taiwan. The products/ services illustrated here may not be available to Taiwan residents. Before proceeding with your investment decision, please consult your investment advisor. Note to Readers: This document is issued in Hong Kong by AllianceBernstein Hong Kong Limited , a licensed entity regulated by the Hong Kong Securities and Futures Commission. This document has not been reviewed by the Hong Kong Securities and Futures Commission.

3