I've spoken before about how central banks view employment and how looking at growth rates of employment, particularly year-on-year growth rates, gives you a feel for how central banks, particularly the Federal Reserve or the RBA, are feeling about the economy.
This is not our model of short rates; our model is based on inflation, unemployment, and inflation expectations, which is completely different. However, if you look at when year-on-year employment is growing faster than the long-term median, you'll see that central banks tend to increase official rates during such periods. Conversely, when year-on-year employment growth is growing slower than the long-term median, central banks will tend to cut rates.
Currently, we have a picture of the year-on-year growth of US payroll employment. The long-term average for the last two decades is 1.6%. Recently, there was significant media coverage of the employment number, and the market fell heavily, with some attributing it to the bad employment numbers. At that time, year-on-year employment growth in the US was 1.6%, exactly the same as the long-term median, so there was no reason to panic.
Since then, we've seen more discussion about downward revisions of US employment growth. The current chart shows a very small downward revision, with the rate of growth falling from the long-term median of 1.6% to 1.5%. That's a decline of just 0.1%, which is hardly anything to panic about.
Looking at the history of US employment, there have been significant variation since 2019. In 2020, employment growth in the US slumped by 13.4% in one year, reaching its lowest point in April 2020. It then recovered by 11% in April 2021. By October 2021, the rate of growth had declined to 3.8%, and it then increased to 5% for the year to February 2022. After that, there was a long-term gradual decline in growth rates, reaching a bottom in February of this year with a growth rate of 1.7%. Around that time, the Fed was optimistic about cutting rates, but the following month saw a surge in employment, which increased the growth rate to 1.9%.
As we enter the second half of the year, employment growth is slowing. Six months ago, there were 157.7 million employed, inn August there were 158.7 million employed. While there is still positive employment growth, it is now increasing at a rate of only 0.7% over the six-month period. Year-on-year growth is now marginally below the long-term average. This allows us to confidently forecast that when the Fed meets again and Jay Powell presents on the 18th of this month, he will announce a cut in the Fed funds rate of 25 basis points.
In addition to this rate cut, the Fed will also release its Summary of Economic Projections. This summary will provide insight into where the Fed thinks interest rates are headed in the period ahead. Once this information is available, I'll provide further analysis on where the Fed believes the US economy is going and how that impacts future rates.
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