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9/6/13 – The Employment Numbers and the Fed

Written by Brad McMillan, CFA®, CFP® | Sep 6, 2013 2:17:00 PM

I was in New York yesterday, meeting with clients and doing interviews, and the one thing everyone wanted to talk about was the employment numbers—the initial unemployment claims earlier in the week and today’s employment figures. Looking at the commentary, one paper called today’s release “probably the most scrutinized employment report in recent history.” So, now that they’re out, it seems only fair to take a look at the numbers.

First, though, let’s talk about why this release is commanding so much attention. The Federal Reserve has explicitly said that the decision to begin reducing its monthly bond purchases—known as “tapering”—will be based on employment and inflation. Given that, this employment release is perceived to be a critical factor in whether the tapering will start in September or be postponed.

The reason the tapering is important is that markets expect interest rates to rise as the Fed’s buying is reduced, and rising interest rates will have effects across the economy. This employment number, therefore, is seen to be the key to whether interest rates go up soon or not. It is a big deal.

So, before we consider what it all means, let’s look at the data. The actual number came in at +169,000, somewhat below the expectations of +180,000—rather disappointing but not significantly so, given the usual noisiness in the data.

The really disappointing part of the report was the downward revisions to previous months’ numbers: 74,000 jobs that had been counted in the preceding two months were eliminated. In July, in particular, only 104,000 jobs are now thought to have been created. Another disappointing result was that the household survey of employment—a separate data series, which can vary significantly from the establishment survey—actually showed a loss of 115,000 jobs.

While these results are weaker than expected and could be worrisome if they continue, other parts of the data were better—much better. Wage income growth and hours worked both ticked up overall. The unemployment rate dropped, although this was a mixed indicator, as the drop was based on a decline in the workforce. Private employment was up 152,000, better than the previous month’s 127,000. Initial unemployment claims dropped again and are at more than a six-year low.

Overall, despite the somewhat disappointing headline results, the report is a mixed bag, pointing to continued slow but steady growth rather than any acceleration. Firings have subsided and are at multiyear lows, but hiring hasn’t yet picked up.

There are two major takeaways for me here. First, private employment growth continues to recover, suggesting that continued weakness in government employment is holding the economy back. Second is the continued decline in the unemployment rate, despite the relatively slow growth in hiring. This suggests that, quite possibly, the decline in the labor force may continue longer than expected—which means the current job growth rate may be better, in context, than we would expect from history.

What does all this mean for the Fed’s tapering decision? The lackluster headline numbers and downward revisions give Fed officials a reason to postpone the tapering if they want one. Economically, I think the case for a September start is still there, even with the recent data. But as I’ve said many times before, the pending political risks—the deficit ceiling, the federal budget, and now Syria and Egypt—provide ample reason to postpone the tapering.

Complicating the decision is that markets have gotten ahead of the Fed on interest rates. With rates on the 10-year Treasury up to 3 percent yesterday, much of the anticipated increase in rates from the tapering has already happened. The potential for rates to go even higher when the Fed starts to taper has to factor into its decision as well.

It will be a close call. My opinion is that, with rates already higher, the additional damage done by tapering will be minimal, if any. In fact, I think there’s even a possibility that rates may tick down after the taper starts, in a classic “sell the rumor, buy the news” market move, although the Fed certainly can’t count on that. Economically, the case for a September start to the taper remains sound. Politically, it’s getting weaker by the day.

At this point, I’m still marginally on the side of a September start, largely because I think the potential interest rate effects of the taper have already hit. If it does happen, though, the actual reduction in bond purchases will be small—a trial balloon, if you will, to see just how much of the taper has already been priced in.