When the Fed began its third round of quantitative easing last autumn, the most recent jobs report in hand was for August, which showed an unemployment rate of 8.1 per cent. Today the unemployment rate is 7.6 per cent. The Fed said it would keep buying assets, currently at a pace of $85bn-a-month, until there is a “substantial improvement” in the “outlook for the labour market”. The question is whether the current data meet that condition or at least bring it close enough that the Fed can start to taper its purchases.
The Fed has made that question very difficult to answer – not least because opinions differ within the institution. “Substantial improvement in the outlook” has turned out to be a dismal bit of communication: every word needs a definition. For example, does it refer to a level of the unemployment rate or the speed of change? What if the unemployment rate was expected to fall to 7 per cent but then get stuck? Is that a substantial improvement?
Nonetheless, the Fed has given some clues, so it is possible to have a stab at answering the question.
(1) When the Fed says outlook, it means outlook
Two of the Fed officials that have created the biggest stir with their comments on tapering QE3 are Eric Rosengren of the Boston Fed and John Williams of the San Francisco Fed. Both were strong supporters of QE3; both have said they are open to a taper fairly soon. It is no coincidence that both have recently presented versions of the same chart.
Here is Mr Rosengren’s version:
And here is Mr Williams:
The crucial point is that, since September 2012, forecasts of where the unemployment rate would be at the end of 2013 have improved a lot. The consensus Fed forecast at the time QE3 began was for 7.75 per cent unemployment at the end of 2013. It is only May and we are already down to 7.6 per cent. That is what is driving the Fed debate about tapering.
What do today’s payrolls figures mean for the unemployment forecast? Carry on at the current pace and unemployment will fall further this year. If that is the forecast, then it constitutes a substantial improvement in the outlook, and will trigger tapering of QE soon.
(2) There are many measures of the labour market, but payrolls is #1
In a speech in March, Fed vice-chair set out a list of indicators the Fed would look at, and the unemployment rate plus the pace of payrolls growth were the top two.
Ben Bernanke also made some remarks in his recent testimony to the Joint Economic Committee of Congress that help to define what a substantial improvement looks like. “Gains in total nonfarm payroll employment have averaged more than 200,000 jobs per month over the past six months, compared with average monthly gains of less than 140,000 during the prior six months,” he said.
From that point of view, there are two ways to look at today’s figures. On one hand, 175,000 is below that 200,000 six-month average, and indeed drags it down to 194,000. The three-month average is weaker still and is now running at 155,000.
On the other hand, both of those figures remain well above the rate when QE3 began. The rise in participation in the labour market is also very encouraging. In essence what that does is allow the Fed to take much greater comfort from the fall in the unemployment rate since last September.
A 175,000 pace of payrolls is not fast enough to force a tapering of QE3. But nor is it incompatible, if sustained, with tapering in September.
(3) Uncertainty is now the biggest issue
If Mr Bernanke or Ms Yellen were asked whether there has been a substantial improvement in the outlook for the labour market since last September, and forced to answer yes or no, I think they would both say “yes”. If allowed to add a proviso, however, they would worry about risks to the outlook from sequestration cuts to public spending.
“For me, the base case forecast is not the sole consideration—how confident we are about that outcome is also important,” said New York Fed president William Dudley in a recent speech. “Over the coming months, how well the economy fights its way through the significant fiscal drag currently in force will be an important aspect of this judgment.”
Today’s payrolls help to resolve the uncertainty: the labour market is doing better than might be expected given the amount of fiscal drag. But they are not enough to give real confidence about the outcome. If jobs growth was above 200,000 and being revised up – if the labour market were getting stronger despite the fiscal drag – then the case for winding down QE3 would be complete.
Today’s jobs report does not quite do that. The Fed is likely to regard it as further evidence the economy is ready for a taper – but that it is worth waiting a few more months to be sure.