The economy added over 2 million jobs in 2017, and this breakneck speed of employment gains pulled the unemployment rate down from 4.8% in January to 4.1% by year-end.5 The challenges imposed by long-run demographic trends have not changed, however, and the labor market could increasingly be a headwind for growth in more ways than one.

Unemployment rate has steadily decreased since 2011 4% 5% 6% 7% 8% 9% 10% January  2011 December 2017 Sources: U.S. Bureau of Labor Statistics, U.S. Federal Reserve, FS Investments, as of December 28, 2017. HOW LOW CAN YOU GO? Unemployment rate (%) Fed estimate of NAIRU

We will be watching: The monthly payroll report will be front and center of the economic landscape again in 2018. In particular, the unemployment rate has now moved well below the Fed’s long-run equilibrium estimate. The Fed expects the unemployment rate to be 3.9% in 2018, but at the current pace of job growth with the economy averaging 172,000 job gains per month,6 the unemployment rate could breach that threshold as soon as the first or second quarter. With growth above trend, the labor market looks set to tighten even further in 2018.

Risks to our view: So far, the Fed has shown little concern about the tightening labor market, and has continued its slow, cautious pace of rate hikes. However, it remains to be seen if the Fed will tolerate an unemployment rate increasingly beyond their own estimate of equilibrium. An unemployment rate below 3.5% could shift the Fed rate hike cycle into a higher gear.

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5 U.S. Bureau of Labor Statistics, FS Investments.
6 172,600 is the average for the past year. U.S. Bureau of Labor Statistics, as of December 28, 2017.

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