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UBS: Here's How We Get To The Fed's 6.5% Unemployment Rate Threshold

The unemployment rate — determined by the balance between job and labor force growth — may become "the single most important interest rate determinant over the next few years," according to the UBS economics team.

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As the unemployment rate falls slowly but surely, many skeptics have pointed to the steady drop in the labor force participation rate (the percentage of adults in the work force).

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UBS

And because future interest rates will be so dependent on the labor force participation rate, UBS takes a look at what the quarterly average unemployment rate will be with various combinations of employment growth and labor force participation rates.

Essentially, UBS is looking at what combinations of labor force participation and job growth gets us to a 6.5% unemployment rate — the rate at which the Fed has said it will consider raising interest rates. From the note:

If the labor force participation rate is unchanged, the so-called “break-even” rate of household-survey employment growth needed to stabilize the unemployment rate would be near the 100,000 per month observed over the past year. What if the 63.3% labor force participation rate in Q313 were to rise by 0.1 percentage point per quarter over the five quarters through Q414 to 63.8%? In that case, “break-even” employment growth would need to almost double to nearly 200,000 per month from the recent 100,000 per month.

Such calculations also can illustrate the various combinations of the labor force participation rate and household-survey employment growth required to reach the two key unemployment levels that could trigger significantly higher interest rates. 

If the labor force participation rate in Q414 is unchanged from 63.3% in Q313, household-survey employment would have to grow by around 185,000 per month to reduce the Q414 unemployment rate to the 6.5% level at which the Fed has said that it would consider starting to raise the Federal funds rate. A cumulative 0.2 percentage point rise in the labor force participation rate to 63.5% by Q414 means that household-survey employment would have to rise by 215,000 per month to achieve a 6.5% Q414 unemployment rate. On the other hand, a cumulative 0.2 percentage point drop in the labor force participation rate to 63.1% by Q414 means that household-survey employment would have to rise by just 150,000 per month to achieve a 6.5% Q414 unemployment rate. 

With retiring baby boomers likely to continue the "downward tug" on the labor force participation rate, UBS writes that "a fair working assumption is that it won’t change much, with the second most likely scenario being a further decline."

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UBS

 

Federal Reserve Interest Rates UBS
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