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Goldman sees unemployment below 4%, job market getting so good it could 'overshoot'

  • Goldman Sachs economists said the job market is doing better than they expected and doing so well it could "overshoot" full employment.
  • The economists revised their forecast for unemployment to 3.8 percent next year from 4.1 percent.
  • The economists expect the Fed will move faster than the market believes to raise interest rates — at a pace of one hike per quarter in 2018 and 2019.

    Goldman Sachs economists say the outlook for jobs is even better than they thought, and unemployment could go as low as 3.8 percent next year.

    The firm's economists, in a note over the weekend, talked about a labor market "overshoot," with the trend in job growth remaining in the 150,000 to 200,000 range, twice its estimate of what the economy needs to maintain a healthy labor market.

    Friday's July employment report showed job growth, at 209,000, well above the consensus 180,000 expected by economists. That follows 231,000 jobs in June, another month in which 200,000-plus growth was unexpected. The unemployment rate fell to 4.3 percent in July, a decline of 0.1 from June.

    The economists forecast the strong labor market should put the Federal Reserve on track to raise interest rates once a quarter, even if inflation remains below the Fed's 2 percent target.

    Missing in the recovery has been a steady rise in inflation, signs of which are also missing in the labor market, in wage acceleration. The markets have doubted the Fed will be able to raise rates because of the lack of inflation, but Goldman economists disagree.

    Looking at such measures as the long-term unemployment rate, job openings and quits, and reports of skill shortages, "the labor market is about as tight as in the full-employment years 2006 and 1989, though not yet as overheated as in 2000. And while the recent hard wage data have mostly disappointed, surveys of wage growth among employers and households signal a wage acceleration to around 3 percent by the end of 2017," they wrote. Wage growth in July was 2.5 percent on an annual basis.

    The economists said broader growth measures also look firm, and third-quarter GDP is tracking at about the same as the 2.6 percent reported for the second quarter. However, the rebound in productivity growth is fading. They forecast second quarter was a weak 0.6 percent.

    The economy needs to grow at a rate of 1 percent to stabilize the unemployment rate in the short term, a pace below their longer-term potential growth forecast of 1.75 percent, they noted.

    "We have made a sizable downward revision to our forecast for the unemployment rate by the end of 2018, 3.8 percent from 4.1 percent previously. Our new forecast is 0.4 pp below the FOMC's median projection as of June and would match the generational trough reached in early 2000," the economists wrote. The last time unemployment dipped below 4 percent was in 2000.

    Unemployment rate (seasonally adjusted)

    Source: Bureau of Labor Statistics

    The economists said it appears that the labor market is likely to "overshoot" full employment, a condition that has resulted in recessions in the past.

    Even so, the economists are sticking with their forecast for Fed rate hikes. "Our subjective probability of a hike by the December meeting remains around 60 percent, and our baseline for 2018-2019 is quarterly hikes," they wrote, noting there are risks to their forecast that could sideline the Fed.

    "But as the labor market overshoots full employment, the distribution is becoming more symmetric, and in any case we think that market pricing of just one hike per year is much too low," they noted.

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