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The Federal Reserve has two specific objectives with regard to monetary policy, price stability and full employment. These two mandates can sometimes be conflicting, so it’s important to review both to see which side policy will likely favor. Ben Bernanke set a specific target inflation rate of 2% in January 2012. He also set an unemployment target of 6.5% while still in office.
There are a few different measures of inflation that are used by the Fed. While CPI and Core CPI are important, the Fed emphasizes price inflation in personal consumption expenditures (PCE). Core PCE, that removes food and energy from the index, is their main concern when considering inflation trends due to the increased volatility seen in food and energy prices. Core PCE measured 1.2% at the end of March. Headline CPI was 2.0% and Core CPI was 1.8% at the end of April. Thus, all main inflation metrics are at or below target.
As of the end of April, the U.S. unemployment rate stood at 6.3%. This is a big improvement from the 10% rate during the recession and slightly below the Fed’s 6.5% target. It’s important to note that unemployment of 5.5% is historically associated with full employment. As with any statistic, it’s important to look at other data to get a better sense of state of the labor market.
Long-term unemployment (lasting more than 27 weeks) decreased by 20.8% year-over-year to 3.45 million in April. Total unemployment was 9.8 million, down from over 20 million during the recession. Consequently, long-term unemployed now represent 35% of total unemployment which is double the rate prior to the recession. Additionally, the number of people who want jobs but are not in the labor force measured 6.1 million. There was a decline in the pool of available labor of 12% year-over-year which curbs some enthusiasm for the gains in the unemployment rate. The labor market is simply not as strong as the gains in unemployment suggest and point to persistent structural unemployment concerns.
We have a low inflationary environment and an employment market that appears weaker beneath the surface. The Federal debt to GDP ratio is at 99.6%, so the worst case scenario with regard to prices is deflation. The Fed will have to speak as if inflation is a concern at times and there may be dissent with Fed members when an inflation metric ticks up, but we believe the Fed will continue to remain accommodative well into next year before raising short-term rates.