5 Reasons the Fed Will Raise Interest Rates Soon

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Federal Reserve
Manuel Balce Ceneta/AP
By Peter Morici

NEW YORK -- On Thursday, the Department of Labor reported that the economy added 223,000 jobs in June -- hardly robust given that monthly gains averaged 260,000 last year -- but still good enough to push the Federal Reserve to raise interest rates soon.

Economists expect stronger consumer spending, housing activity and business construction to boost gross domestic product growth to nearly 3 percent by the second half this year.

Stronger productivity -- not accelerated jobs creation -- will support expansion. That should convince the Fed that the American economy is finally getting healthy and easy credit has done as much as it can to heal labor markets.

Here are five reasons why.

First, the historic pace of productivity growth is close to 2 percent a year, but thanks to West Coast port slowdowns, a severe winter and lower oil prices, worker productivity fell a lot last fall and winter. Businesses have too many underutilized employees, and with growth picking up, employers will use those already in the door to help meet higher demand. Second, business balance sheets and tangible competitive assets are remarkably stronger than in recent years. A lot has been made of companies using extra cash to buy back stocks, but debt-to-equity ratios are down.

Quietly, businesses have been purchasing new equipment and software and tightening supply chains to sharpen execution. Investments for these purposes relative to depreciation have been stronger than during the boom years of the past decade, and we can expect a burst of productivity soon.

It may already be happening, but we haven't seen second-quarter data yet.

Third, as much as businesses see opportunities to raise sales and productivity, the latter requires more skilled workers than they can find. Many unemployed workers including those with college degrees working in coffee shops or hawking cell phones only have general educations or lack the problem-solving skills to be effective in high-performance work environments where career ladders and high wages await.

Fourth, merger and acquisition activity this year is on pace to challenge the record set in 2007. Although the desire to accomplish the benefits of scale and synergies by combining complementary assets is always present, businesses increasingly cite the absence of skilled workers as a key constraint on internally generated growth.

Many fewer jobs are being cut during the current M&A frenzy than were eliminated during the heady days of the mid-2000s because businesses are using these new combinations to get the workers that they can't find in the job market.

Finally, the strong dollar remains a constraint on GDP growth, both by cheapening imports and making goods made by U.S.-based workers more expensive for export to foreign markets. Even firms doing well assembling products in the United States such as automakers are importing more components to keep costs down.

All this spells a more robust American private sector even if blemished by a strong dollar and labor shortages that constrain what it can deliver. Average wages remain stagnant because good-paying job openings go wanting for lack of qualified applicants, and an army of low-skilled workers in the service sector pulls down average wages.

Expect jobs growth to remain at about 220,000 a month, but continued low rates can't do much to fix problems emanating from a broken educational system and other social ills.

Fed policymakers have good reason to want to return rates to more historically normal levels. Keeping short rates low for more than six years has encouraged too much speculation and bubbles in real estate, junk bonds and other asset markets, and it is time to rein all that in before it poses threats to financial stability. Fed Chairman Janet L. Yellen will likely read the situation this way and raise the federal funds rate a notch in September and a bit more before the year ends.

This article is commentary by an independent contributor.
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