The market thinks the June jobs report is taperific and that looks basically correct: at this pace of payrolls growth a September slowing of QE3 seems likely. But there are enough complications to make the market reaction – 10-year Treasury yield up eighteen basis points at 2.68 per cent – look over the top.
(1) The jobs report fits the Fed’s optimistic economic scenario. Ben Bernanke’s scenario for a taper later this year was based on a more optimistic economic outlook than most forecasters, with “continuing gains in labour markets, supported by moderate growth that picks up over the next several quarters”. Today’s report fits the bill. Most crucially, the report suggests that jobs momentum in recent months was stronger than previously thought. In his May testimony, Bernanke said that “gains in total non-farm 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”. After today’s jobs report, the six month average is above 200,000 again.
(2) However, there is a gap between payrolls and indicators of GDP growth. The second part of Mr Bernanke’s condition was “supported by moderate growth” and a range of other data, such as exports and consumption, point to a weak second quarter. Macroeconomic Advisers, an economic consultancy, estimates growth at an annualised pace of just 1.3 per cent for the second quarter followed by 2.6 per cent in the third quarter. Payrolls tend to lag the rest of the economy a bit so it will be no surprise if they slow in the coming months. We will get both July and August payrolls data before the September FOMC meeting. A modest slowdown would be unlikely to prevent the start of tapering. But the Fed remains a slave to the data and the data could yet turn weak enough to stay its hand.
(3) Higher participation could slow tapering and delay rate rises. The size of the labour force has increased by 807,000 in the last three months and that has been enough to keep the unemployment rate frozen at 7.6 per cent. The tapering forecasts that Mr Bernanke laid out at his last press conference have unemployment at 7.25 per cent by the end of the year and 7 per cent by the middle of 2014. This is unlikely to change the start date for a taper. But if participation continues to rise, pointing to greater slack in the economy, it could mean that the Fed takes more time to wind its purchases down to zero. Perhaps more importantly, it would push back the date at which the economy hits the Fed’s 6.5 per cent unemployment threshold for a first rise in interest rates.
(4) The market is not reacting as the Fed’s models would predict. The Fed thinks that the total size of its balance sheet over time is what affects the economy. There is nothing in today’s jobs report to significantly change expectations of that size: perhaps it brings forward the path of tapering slightly but nothing to justify a 20 basis point jump in ten-year Treasury yields. The market is proving hugely sensitive to perceptions about the flow of Fed purchases. So far, the Fed has shrugged that off, and tried to communicate that tapering simply means a slower pace of monetary easing rather than any tightening of policy. However, the big jump in bond yields will feed back into lower Fed forecasts for economic growth – and that in turn will affect its calculus on tapering.
(5) Underlying all this, the US economy seems a lot healthier. Today’s solid jobs growth came despite a decline in government and manufacturing employment. That such growth in payrolls is possible despite a huge fiscal squeeze and no help from the rest of the world is the most encouraging sign of all. This resilience is likely to boost the Fed’s confidence in its forecasts for 2014, when fiscal policy should be more helpful, and that more than anything will spur its officials towards a slowing of the exceptional stimulus that its third round of quantitative easing was always meant to be.