Recent data show that the U.S. economy expanded at a 4.2% annualized rate during the second quarter, after a rather sluggish start to the year. Furthermore, there is good reason to believe the economy is beginning to feed off itself in a sort of self-sustaining growth cycle.

However, this news might not be all good. The Federal Reserve is widely expected to begin raising interest rates once it appears the economy is strong enough to stand on its own two feet. Will the recent growth give the Fed enough confidence to make its move?

Source: flickr

The data look good at first
The GDP expansion is just one part of a stream of recent positive economic news.

The latest four-week average of U.S. unemployment claims is 304,000, which is more than 7% less than the same time period a year ago. And, the U.S. unemployment rate is down to just 6.1%, the lowest it's been since 2008.

Consumer sentiment is booming as well, with the latest data showing the index at 84.6, the highest level in more than a year.

Some economists believe we are headed into an almost self-perpetuating economic expansion in which job gains will boost consumer confidence, which will boost retail sales. Also, Americans have been paying down debt, which lowers their costs of borrowing, which increases the savings rate.

But there are still some big issues
So on the surface it appears the economic recovery is alive and well. However, these numbers don't tell the whole story. There are still some big problems facing the economy, especially regarding employment.

A better measure of the employment picture in the United States is the U-6 unemployment rate, which includes certain groups not counted in that 6.1% figure that's in the headlines. The U-6 calculation adds in those underemployed workers, those employed below their skill level or for fewer hours than they want. It also includes "discouraged workers," those who have been looking for work so long that they've given up searching.

When you add these groups in, the "real" unemployment rate is about 12%. The gap between the "U.S. unemployment rate" and the U-6, then, is the number that indicates the recovery still has a way to go. Right now, roughly 6% of the population is underemployed or discouraged.

You can see on the chart below that during healthier economic times, this gap was closer to 4%. In other words, we have 50% more discouraged workers now than we did before the recession.

US Unemployment Rate Chart

Also, wage growth (or the lack thereof) is rather discouraging. According to a recent report from the Economic Policy Institute, wages declined over the past year for workers at all pay levels except the lowest 10%. In fact, wages for all groups are still lower than at the end of the recession in 2009. There is no sign of this changing anytime soon.

Most likely scenario
Until both wage growth and unemployment improve, I don't foresee the Federal Reserve raising interest rates.

There has been tremendous progress made in the recovery so far, but there is still much to be done, and the Fed knows this. Furthermore, the Fed is terrified of inadvertently reversing the progress that has been made so far, and will most likely err on the side of caution before considering a rate hike.

In short, until there are real signs of wage growth in the U.S., and significant progress toward reducing the proportion of underemployed and discouraged workers, interest rates are likely to stay at their current low levels.

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