So Now What?

What did we learn last week? The Fed may not be in any hurry to begin reducing the rate of asset purchases. The economic data suggest a mixed picture.

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The financial press described July’s 162,000 rise in nonfarm payrolls as “weak.” Really? A 10,000 increase would be “weak.” Granted, the July increase is not going to take up much of the slack in the labor market, but +162,000 is not horrible. The key point is that we’d like to see payroll gains on the order of 250,000 or more, month after month, for a few years, but the economy continues to face headwinds in the near term, including tight fiscal policy and a sluggish global economy.

Looking at the unadjusted payroll figures, the recent trend has been similar to what we experienced in 2006 (nearly the same level and seasonal pattern). We’re still not making up much of the ground that was lost during the downturn. More importantly, we should be much further ahead in jobs given that we’ve continued to add to the overall population.

The unemployment rate fell to 7.4% in July, the lowest since December 2008. However, as with most of the decline over the last few years, that was largely due to lower labor force participation. Some of the downtrend in participation, perhaps a quarter, is demographics, reflecting the aging of the population. However, most is due to other reasons. To be officially counted as “unemployed,” one has to be actively looking for a job. Many have given up. The household survey data continue to show a high level of long-term unemployment and these figures understate the magnitude of the problem.

Real GDP growth was stronger than expected in the advance estimate for 2Q13. Comprehensive revisions to the GDP data did not alter the pattern of growth over the last few years by much, but did reduce the growth estimate for 1Q13. The introduction of intellectual property products (research and development, investment in entertainment) did not generate much confusion for the financial markets. Real GDP rose 1.4% over the first half of the year, the same pace as in the last half of 2012. That’s not especially strong. Growth would have been a lot stronger if not for the payroll tax increase and the sequester.

In its July 31 policy statement, the Federal Open Market Committee adopted a more dovish tone. Chairman Bernanke has indicated that the Fed would likely begin to taper the rate of asset purchases this year, provided that the economy improved as anticipated. However, the FOMC noted that growth has been “modest,” that mortgage rates have risen “somewhat,” and that a persistent low trend in inflation could generate some risks for the economy. None of that suggests that the Fed is in any hurry to reduce the rate of asset purchases. Recall that the purpose of QE3 was to get the ball rolling, to impart some forward momentum into the economy. The Fed would still be adding monetary accommodation as it tapers, and low short-term interest rates would continue to provide support for the economy when asset purchases are completed. The Fed was caught off guard by the financial market reaction to the talk of tapering. From the Fed’s point of view, it doesn’t really matter much whether it begins to slow the rate of asset purchases in September, December, or in early 2013. Tapering is not tightening. Yet, the bond market reacted as if it were. That reaction has given the Fed pause. Officials must now take into account how the markets will react to the tapering. Fed communications will be important, but it’s hard to fault Bernanke. He was clear in citing the Fed’s intentions, but that message wasn’t well received by the markets.

The bottom line is that we essentially have “more of the same,” a gradual economic recovery, with glacial improvement in the labor market. Looking ahead, the markets will have a long wait until the August Employment Report.

© Raymond James

© Raymond James

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