The Fed Policy Outlook

Much of the recent economic data have been distorted by adverse weather, which makes it difficult to gauge the underlying strength. However, while economic activity appears to have slowed in early 2014, the longer-term outlook hasn’t changed. Growth should pick up. The Fed’s tapering of its asset purchase program is “ not on a preset course,” but officials are expected to continue with “ measured steps ” (-$10 billion per policy meeting), unless there is a significant change in the economic outlook. With the unemployment rate nearing 6.5%, the Fed is going to make adjustments to its forward guidance, but the intent (that short-term interest rates are likely to stay near zero well into 2015) is expected to remain.

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The economic data for the winter months should always be taken with a grain of salt. Seasonal adjustment is large and can magnify even minor impacts from the weather. The weather has been hardly minor this year. Poor weather appears to have distorted figures for December, January, and February. The impact can vary a lot, depending on which areas of the country get hit and when. Furthermore, you may see a bounce-back from the weather in some regions, but worse conditions for others. Bottom line: take the data reports with a grain of salt.

Recall that the Employment Report consists of two surveys. The household survey is a telephone survey of 60,000 households. That may not sound like a lot. You’re not going to get accurate monthly measurements of levels (the number of unemployed, the size of the labor force), but you get reasonable estimates of ratios (the unemployment rate, labor force participation). The BLS estimates that 601,000 individuals could not get to work due to poor weather during the survey week (vs. a 237,000 a year ago. These people are still classified as “employed.” Note that this figure is not comparable to the nonfarm payroll data, which come from a different survey.

The establishment survey covers about 144,000 businesses and government agencies (about 554,000 individual worksites), which are asked about the number of employees, hours, and wages for the pay period that includes the 12th of the month. The data are reported on a seasonally adjusted basis. Prior to seasonal adjustment nonfarm payrolls rose by 750,000 in February, largely reflecting an increase in education (+693,100, following a decline of 811,500 over the two previous months). Ex-education, unadjusted payrolls rose by 56,900 (vs. -2.219 million in January and +324,700 in February 2013). The pattern in the unadjusted payroll figures is close to the usual, but figures suggest some impact from the weather. The data for March, April, and May will be more important, providing a clearer picture of the underlying strength of the labor market.

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The unemployment rate edged back up to 6.7% in February (from 6.6% in January). However, the Bureau of Labor Statistics notes that a 90% confidence interval for the monthly change in the unemployment rate is ±0.2%. In other words, the reported increase in the unemployment rate in February is not statistically different from zero.

Former Fed Chairman Bernanke described the unemployment rate as the best single measure of the strength of the labor market. Others might disagree, preferring to look at a wide range of labor market indicators. Long-term unemployment remains elevated. Rates of unemployment for teenagers and young adults are a lot higher than normal. Measures of underemployment continue to suggest a large amount of slack.

The 6.5% unemployment rate threshold in the Fed’s forward guidance has outlived its usefulness. At the January FOMC meeting, Fed officials debated on how to alter the language, but were far from an agreement. We should see that issue settled in the statement on March 19. Fed Chair Yellen should note that short-term rates aren’t going to go up anytime soon.

© Raymond James

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