Making sense of the forces driving global markets

By Jamie McGeever, Reuters Open Interest Markets Columnist 

U.S. shares sank on Wednesday, with tech hit by renewed worries over the AI trade, while Washington's blockade of all oil tankers under sanctions entering and leaving Venezuela lifted oil prices from their five-year lows.

More on that below. In my column today I look at so-called 'U-star', the theoretical, natural rate of unemployment that neither spurs or slows inflation. It could influence Fed officials' thinking in the coming months. A lot.

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Speculation over who U.S. President Donald Trump will pick to replace Fed Chair Jerome Powell is heating up, and it appears to be a three-way race between Kevins Hassett and Warsh, and current Fed Governor Christopher Waller. 

Trump and Treasury Secretary Scott Bessent insist the successful candidate will come under no political pressure. But investors are skeptical. Trump, who wants interest rates at 1% next year "or maybe lower", also wants to be consulted on policy decisions. How independent will the new Fed chair really be?

The murky, entangled web of financing between tech firms for big AI projects has been unnerving investors for months, and on Wednesday they got another dose of the jitters after a $10 billion agreement between alternative asset manager Blue Owl and Oracle broke down. 

Tech giant Oracle is heavily indebted and its shares have slumped nearly 50% since September. The worry is Oracle is over- leveraged and will struggle to make a return on its huge capex investments. The same goes for others, and the bar for allaying those fears appears to be getting higher.

Global oil prices this week sank to their lowest in nearly five years, weighed down by worries over demand - especially from China - and potential signs of a Russia-Ukraine peace deal. U.S. President Donald Trump may have just put a floor under them. 

Trump's complete blockade of all sanctioned oil tankers entering and leaving Venezuela could tighten crude supply, and leaving aside questions around the legalities of the blockade, it also raises geopolitical tensions.  

There is much discussion in U.S. economic circles around "R-star", the theoretical rate of interest that neither spurs nor crimps economic activity. But Federal Reserve officials could soon shift their focus to "U-star". 

That's the similarly theoretical rate of unemployment that neither accelerates nor slows inflation, also known as "NAIRU", or the non-accelerating inflation rate of unemployment. It is likely to influence the Fed's thinking significantly in the months ahead as policymakers attempt to make sense of the head-scratching employment landscape.

Figures on Tuesday suggest the U.S. labor market continues to deteriorate as year-end approaches, though given the government shutdown, labor supply quirks, data collection issues and other technical distortions, this data comes with a major health warning.

Still, the jobs market is sputtering. Hiring is sluggish - the economy may actually be shedding jobs once revisions are factored in - wage growth is slowing and the unemployment rate has climbed to a four-year high of 4.6%. 

In theory, a labor market that weak should signal softening economic demand and slowing inflation. But in reality, activity is holding up pretty well, and inflation has remained stuck around 3% for two years, outpacing the Fed's 2% target for five years running.

This raises the question of where "U-star" is – or where it should be – and whether further policy easing is warranted. According to the Fed's latest Summary of Economic Projections last week, officials' median estimate of "U-star" is 4.2%, where it has been since June last year.

Yet the unemployment rate is 4.6% and steadily rising. Most Fed officials say uncertainty around the unemployment rate is high, with risks skewed to the upside, especially as slow hiring could quickly morph into outright firing. 

So, unemployment is above Fed officials' estimate of "U-star", yet inflation isn't falling. This implies "U-star" may be higher than current models suggest. If so, there's a debate to be had among the 19 rate-setters on the Federal Open Market Committee.