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Eight Reasons Why the Fed Will Not “Taper” in September (An Update)

Just before the FOMC statement on September 18, I think it’s interesting to make an update of my post concerning arguments against “tapering”.

 

Indeed, notwithstanding the fact that the expansionary Fed policy poses risks to financial markets’ stability, especially with the increasing volume of speculative positions (corporate high yield, jumbo loans…), at least eight reasons are still legitimizing a wait-and-see policy in the short term:

 

1/ The lack of short-term agreement on fiscal issues, more specifically on the “continuing resolution” and the 2014 budget. Currently, Republicans insist on keeping automatic budget cuts which will take effect during the 2014 fiscal year (starts on October 1st) and will reach $109B (0.6% of real GDP).

 

-> Senate Majority Leader Harry Reid said last Thursday that deep divisions within the House Republican caucus are imperiling passage of a fiscal year 2014 stop-gap spending bill and threaten both a government shutdown and a default. Note that this bill would keep the government funded until Dec 15 and should include sequestration of $109 billion.

 

2/ The threat of automatic budget cuts, which outcome would not be known from the end of September, comes at a time when growth has been low since the beginning of the year. Indeed, even with an upward revision of the 2Q GDP to 2.5% (QoQ annualized), GDP should increase by 3.1% in 3Q and 4Q to meet the projected 2013 growth defined by the Fed in June (ie 2.45% from 2012 4Q to 2013 4Q).

 

-> The last statistics (August retail sales, Wholesale inventories…) suggest that actual growth (3Q) is below 2%.

 

3/ The signals from the residential housing market are deteriorating. The recent rise in mortgage rates (highest since April 2011) weighed very negatively on refinancing activity (13 declines recorded in the last 16 weeks) but also on new home sales (-13.4% MoM in July). There is no doubt that existing home sales should fall in August, according to the pending home sales’ decline in July (-1.3% MoM).

 

-> Mortgage applications decreased 13.5 percent from one week earlier, according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending September 6, 2013 (14 declines recorded in the last 17 weeks). The Refinance Index decreased 20 percent from the previous week and has fallen 71 percent from its recent peak (the week of May 3).

 

4/ Inflation is broadly in line (PCE inflation) or below (PCE Core Inflation) the Fed’s forecasts made in June. Anyway it remains well below the 2% target, which is the medium-term reference.

 

5/ Regarding the labor market, it must be recognized that since the set-up of the buyback program (September 2012), pace of nonfarm payrolls has improved whereas unemployment rate has decreased. However, the last report (August) underlines that the short term momentum of NFPs is weakening and is still below the threshold of 200K which is not a minimum acceptable for Fed:
-> Moving average 3 months: 148K
-> Moving average 4 months: 155K
-> Moving average 5 months: 164K
-> Moving average 6 months: 160K

- Also, as pointed out by the Fed members during the last Fed Minutes, qualitative indicators, namely the number of long-term unemployed (more than 27 weeks), the number of full-time jobs or the “underemployment rate”, are only improving slightly. Similarly, the decline in the unemployment rate is mainly explained by a fall of participation rate (lowest since Aug 1978) which is not a good thing.

 

6/ The Syrian conflict could create uncertainty to the extent that the debt ceiling has not been raised. The fact is that military action could increase public spending above expectations and therefore could reduce the time remaining to politicians to find a compromise. Currently, according to Treasury Secretary, the deadline sould be reached by mid-October.

 

-> A diplomatic breakthrough Saturday on securing and destroying Syria’s chemical weapons stockpile averted the threat of U.S. military action for the moment. It means that Syrian conflict is not a longer an argument against tapering.

 

7/ During the G20, IMF noted that currently emerging economies are seen as particularly vulnerable to a tightening of US monetary policy and recommended that policy makers be ready to handle a rise in financial instability. In this context, Fed could choose to give more time to other policy markers.

 

8/ Fed communaction: The Fed members have not yet defined criteria or thresholds which would impact the asset purchase program.

- Moreover, since last FOMC, almost all members (voters and non-voters) have instisted on the fact that “tapering” will be only dependent on data which were clearly weaker than expected. The last Beige Book comfirms that activity continued to expand at a modest to moderate pace during the reporting period of early July through late August.

- Finally, some people forget that voters are more “dovish” that non-voters and that they give less press interviews.

- All Fed members’ speeches concerning QE and economic activity since the last FOMC meeting (July 30-31) are available here.

 

To replace my argurment on Syrian conflict, I choose to focus on future changes at the head of the Fed.

 

8bis/ Changes at the head of the Fed in 2014. The next year, the voting members will be more “hawkish” with the arrival of Fisher (Dallas Fed President) and Plosser (Philadelphia Fed President). Therefore, knowing that committee in place in 2014 would quickly end the asset purchases program, the actual committee could delay “tapering” to compensate.

Employment Report Shows that Labor Market Conditions Have Only Improved Slightly in July

According to the Bureau of Statistics, total nonfarm payrolls increased by 162,000 in July (below expectations), and the unemployment rate fell 0.2% to 7.4% against 7.5%e. The average workweek for all employees on private nonfarm payrolls dropped to 34.4 hours in July while average hourly earning decreased 0.1% MoM:

 

From BLS:

 

Total nonfarm payroll employment increased by 162,000 in July, with gains in retail trade, food services and drinking places, financial activities, and wholesale trade.
 
The change in total nonfarm payroll employment for May was revised from +195,000 to +176,000, and the change for June was revised from +195,000 to +188,000. With these revisions, employment gains in May and June combined were 26,000 less than previously reported.
 
Both the number of unemployed persons, at 11.5 million, and the unemployment rate, at 7.4 percent, edged down in July.
 
The average workweek for all employees on private nonfarm payrolls decreased by 0.1 hour in July to 34.4 hours.
 
In July, average hourly earnings for all employees on private nonfarm payrolls edged down by 2 cents to $23.98, following a 10-cent increase in June.
 
In July, the number of long-term unemployed (those jobless for 27 weeks or more) was little changed at 4.2 million.
 
The number of persons employed part time for economic reasons (sometimes referred to as involuntary part-time workers) was essentially unchanged at 8.2 million in July.

 
I – My view:
 
1/ Nonfarm payroll figures were below expectations such as average hourly earnings and average weekly hours worked suggesting that incomes and consumption spending will only progress slightly in July.
 
2/ Moreover, the decrease of wages associated with the drop of the “Price Paid” component of the ISM manufacturing show that inflation could slow in the coming months confirming the recent Fed remark.
 
3/ The short term momentum of NFPs is still below the threshold of 200K which is not a minimum acceptable for Fed:
-> Moving average 3 months: 181K
-> Moving average 4 months: 183K
-> Moving average 5 months: 177K
-> Moving average 6 months: 201K
 
4/ Concerning qualitative indicators, even if the number of unemployed people decreased (-263K), the number of persons employed part time for economic reasons and long-term unemployed (those jobless for 27 weeks or more) were little changed. Besides, the fall of unemployment is also explained by a new decrease of participation rate (-0.1% to 63.4%).
 
 

II – Implications on Fed:
 
Even if labor market conditions are improving slightly, we are far away from Fed’s targets. Most of qualitative indicators were little changed in July and the fall of unemployment rate could be reversed next month with a rise of participation rate.
 
Based on the report, we could only expect a small improvement concerning incomes and consumption spending which is coherent with the drop of new auto sales (-1.8% MoM) in July. Industrial production should stagnate because even if NFP rebounded in the manufacturing sector (+6K), weekly hours worked decreased from 40.8h to 40.6h.
 
Finally, the decrease in wages suggests that inflation pressures are easing.
 
Therefore, my conviction remains that consensus view of “tapering” in September is not realistic in a context where fiscal uncertainty will remain in Q3 until lawmakers find an agreement on “continuing resolution” and 2014 budget.

US July Employment Report: A Preview

Today, the BLS will publish July Employment report and it will give more details regarding the labor market situation. The Bloomberg consensus expects nonfarm payrolls to decrease by 10K in July to 185K and unemployment rate to reach 7.5%, down from 7.6% in June.

 

My conviction is that nonfarm payrolls could be above the consensus in a context where most of proxies suggest better labor market conditions (in line with Fed comments):

 

1/ (+) During the survey period (2nd week of July), the four-week moving average of initial claims decreased from 348.5K (2nd week of June) to 346.5K.

 

2/ (-) On the same period, continuing claims rose from 2987K to 3003K.

 

3/ (+) “Employment” component (Hard to get a job minus Plentiful) of the Conference Board rose from -25.8 in June to -23.3 in July.

 

4/ (+) The ISM manufacturing employment index increased in July to 54.4 from 48.7 in June confirming the trend recorded by the regional surveys (New York, Philadelphia, Dallas…)

 

5/ (+) The ADP employment report showed an increase of 200,000 private sector payroll jobs in July up from 198K in June. Prior ADP Employment Change revised higher from +188K to +198K.

 

6/ (-) Online advertised vacancies dropped 92,200 in July to 4,888,100, according to The Conference Board Help Wanted OnLine (HWOL) Data Series just released.

 

7/ (+) Gallup’s seasonally adjusted U.S. unemployment rate for July is 7.4%, a slight decline from 7.6% in June.

 
These data sent positive signals as hirings in the manufacturng sector could rebound in July. My feeling is that the climate was again milder in July which could be a boost both for catering, leisure and also construction. Moreover, government hirings could stabilize with improving public finances. As a consequence, I expect a slight improvement in nonfarm payrolls and a number above the consensus.

June Employment Report Shows Improvement regarding Quantity but not Quality

According to the Bureau of Statistics, total nonfarm payrolls increased by 195,000 in June (above expectations), and the unemployment rate remained unchanged at 7.6% against 7.5%e. The average workweek for all employees on private nonfarm payrolls was unchanged in June (34.5 hours) while average hourly earning rose 0.4% MoM:

 

From BLS:

 

Total nonfarm payroll employment increased by 195,000 in June, in line with the average monthly gain of 182,000 over the prior 12 months. In June, job growth occurred in leisure and hospitality, professional and business services, retail trade, health care, and financial activities.
 
The change in total nonfarm payroll employment for April was revised from +149,000 to +199,000, and the change for May was revised from +175,000 to +195,000. With these revisions, employment gains in April and May combined were 70,000 higher than previously reported.
 
The number of unemployed persons, at 11.8 million, and the unemployment rate, at 7.6 percent, were unchanged in June.
 
The average workweek for all employees on private nonfarm payrolls was unchanged in June at 34.5 hours.
 
In June, average hourly earnings for all employees on private nonfarm payrolls rose by 10 cents to $24.01. Over the year, average hourly earnings have risen by 51 cents, or 2.2 percent.
 
In June, the number of long-term unemployed (those jobless for 27 weeks or more) was essentially unchanged at 4.3 million.
 
The number of persons employed part time for economic reasons (sometimes referred to as involuntary part-time workers) increased by 322,000 to 8.2 million in June.

 
I – My view:
 
1/ Nonfarm payroll figures were above expectations such as average hourly earnings (largest MoM rise since July 2011) suggesting that incomes and consumption could accelerate significantly in June.
 
2/ Nevertheless despite higher revision the last two months, the short term momentum is still below the threshold of 200K which is not a minimum acceptable for Fed:
-> Moving average 3 months: 196K
-> Moving average 4 months: 183K
 
3/ The fact is that 200K is only sufficient to absorb new entrants but does not allow to push the number of unemployed lower:
-> The number of unemployed people rose slightly: +17K at 11.777K
 
4/ The other qualitative indicators show very poor performance as:
-> The long-term unemployed (those jobless for 27 weeks or more) was essentially unchanged (-29K) at 4.3 million.
-> Underemployment rate rose from 13.8% to 14.3% because the number of “part time employed for economic reasons” rose 322K.
-> Part-time jobs soared by 360K to 28.059K – an all time record high – while full time jobs were down 240K.
 
II – Implications on Fed:
 
Even if inflation expectations rise because of wage pressures, the employment situation only improved slightly regarding quantity and deteriorated concerning quality. Moreover, another important fact is that participation rate rose the last two months suggesting that a part of people which disappeared from statistics because of cyclical factors (not demographic), is coming back and could support unemployment rate in the coming months.
 
As a consequence, I believe this report does not represent a support for Fed to taper the asset purchases program before December. This view is not shared by Goldman Sachs and JP Morgan:
 

June hiring strength makes it more likely the Federal Reserve will slow its bond buying program in early autumn, rather than at the close of the year, economists at two top Wall Street banks said Friday.
 
Saying the June hiring news was “not too shabby,” JPMorgan economist Michael Feroli told clients in a note that he now expects the central bank to trim what is currently an $85 billion per month bond buying program in September. Before the jobs report, Mr. Feroli had expected the Fed to set in motion the bond buying slowdown in December.
 
Meanwhile, Goldman Sachs also penciled in a September slowdown in Fed bond buying, from December. Noting the June jobs data was better than expected, they liked the payrolls growth, revisions to prior months’ data and the increase in earnings. They downplayed the unchanged unemployment rate amid favorable changes in the number of workers relative to the size of the broader population and overall labor force.