US labour market slack to diminish faster than Fed projects

The June summary of economic projections showed that the US unemployment rate likely to reach 5.2-5.3% on average in Q4 this year. Further, the long-run unemployment rate (NAIRU) is projected to be 5.1%. Danske Bank, therefore, expects the Fed to hike in September rather than wait to December is developments in the labour market.

The unemployment rate is likely to reach the longer term target rate of 5.1% in  September and heading lower from there, estimates Danske Bank. The FOMC projections of the unemployment rate seem to be based on relatively optimistic assumptions about a rebound in both labour productivity and the participation rate in coming months. 

"We too project an upturn in labour productivity over the coming year and a cyclical rebound in participation rates but think these adjustments will happen more gradual. Given our assumptions unemployment should be heading below 5% by early next year if we are right that GDP growth will remain around 2.5-3.0% in H2", says Danske Bank.

With fundamentals supportive of a continued recovery in the US economy and the labour market next year. Therefore, Danske Bank anticipates the tightening cycle to continue in 2016 and look for another 100bp in rate hikes. Further, the bank expects the terminal fed funds rate to be around 3.5% by end-2018.