Unemployment and Rate Hikes

Since 1954, the Federal Reserve has only begun raising rates after unemployment peaks. Recent comments by Fed officials reinforces this expectations. Most recently, St. Louis Fed's Bullard that he would like to see job growth and unemployment easing before hiking rates. The perennial hawk Lacker from the Richmond Fed was one of the few that suggested that rates may need to be raised before unemployment peaked.

Two central banks have already begun raising interest rates--Israel and Australia. It is interesting to note that neither may have experienced a peak in unemployment. In fact the Israeli central bank acknowledged that it expected unemployment to rise further in Aug. The consensus is for a tick up to 8% from 7.9% that has prevailed since the spring. It would represent a new cyclical high and the highest since the fall of 2006.

Australia hiked rates on Oct 6th. The following day, the Sept employment report was stronger than expected. The unemployment rate which was expected to have risen to 6% from 5.8% instead slipped to 5.7%. One month a trend does not make and Australia's unemployment rate did slip in April to 5.5% from 5.7% in March only to make a new cyclical high in June at 5.8% where it remained until the Sept report.

Many expect that Norway will be the next to hike. The Norges Bank meets on Oct 28, with the deposit rate set at 1.25%. A stronger case can be made in Norway that the unemployment rate peaked back in March at 3.2%. It stood at 2.7% in Sept, with the Oct report due the same day the central bank meets. A 25 bp rate hike has largely been discounted in the money markets and the krone has been the best performing currency against the US dollar over the past month--(6.1% vs 5.5% for the Australian dollar and 4.8% for the Canadian dollar).

A Bloomberg survey of economists find the consensus expects US unemployment to peak in Q1 10 at 10.1%. But the consensus may conceal great variance. The most pessimistic forecasts do not see unemployment peaking until Q2 10 near 11.4%. Unemployment peaked in the early 1980s recession near 10.8%. The most optimistic expect unemployment to be peaking around now. The Fed funds futures strip has odds of a rate hike increasing through the first quarter next year, but the pricing indicates that a 50 bp Fed funds target is not completely discounted until late in Q2.