A quick look at the July employment report seems to reinforce the importance of participation rates in the path to the 6.5% unemployment threshold Fed Chairman Bernanke laid out last December. As we’ve speculated, meager gains in employment can have a material impact on the unemployment rate because so many people are leaving the workforce due to demographic changes. Unemployment fell in July by a whopping 0.2%, from 7.6% to 7.4%, on the back of just 162,000 new jobs! Again, the policy implications of this are clear: we are marching more quickly toward the 6.5% target than simple economic intuition might lead one to believe.
We believe the purpose of the Feds’ economic thresholds is to allow market forces to more actively determine interest rate and credit market conditions; as the economy gets closer to (or further from) the inflation and employment targets that have been established, markets will adjust accordingly. By the time it becomes appropriate to raise short term rates, the rest of the yield curve will have adjusted ahead of time. Rather experiencing a shock throughout the curve, this should lead to a smoother exit from ultra-low rates than many anticipate. The mid-May through June experience shows just that adjustment in action:
Source: US Treasury