Tim Duy looks through the eyes of monetary policymakers at today's employment report and its impact on the course of monetary policy:
What better way to return from a long winter break than to tackle a muddled labor report! I suspect that we will find many stories told about this report, and I will try to summarize all of them (Kash at Angry Bear was out of the gates early with the pessimist’s take). But what is most important – from a FedWatch perspective – is the view at Constitution Ave. I tend to think that despite a few setbacks in the details, policymakers will walk away with a relatively upbeat perspective on the labor markets. And that means it may be premature to think the Fed will shortly be done for good.
But first, a quick look back at the Fed minutes. Wall Street’s stamp of approval implies a wide expectation of “one and done” for this tightening cycle. That’s not quite my interpretation, although I can’t blame traders for looking for good news after a dreary December. Instead, I left the minutes with the sense that another rate hike at the end of the month is in the bag, but beyond that, future changes in policy are not automatic but instead data dependent. That is decidedly not the same thing as “done.” “Done” means you are betting against the economy – and I doubt the Fed is ready to make that call just yet.
As far as the labor report goes, the headline payroll gain of 108,000 was clearly a disappointment. But optimists will point to the revision that pushed the October gain to 305,000 jobs, which yields a respectable two-month average of just over 200,000. Optimists will point to the decline in the unemployment rate to 4.9%; pessimists will focus on the decline in the labor force participation rate. Pessimists will focus on the slight fall in aggregate hours worked; optimists will point to the 5 cent wage gain.
Some other details popped out at me. The 18,000 gain in manufacturing employment should be happy news to many, although my initial scan of the blogs does not show a focus on this number. In contrast, the decrease in construction employment could reflect cooling housing markets. While many expect those jobs will eventually show up in Gulf Coast rebuilding efforts, only in macroeconomic textbooks does a worker move from San Diego to New Orleans instantaneously and at zero cost.
So, what will policymakers make of all of this? First of all, it is always important to remember that one month of a single data report is not likely to fundamentally alter the perceptions on Constitution Ave. We will have two more of these reports – not to mention dozens of other data points – by the time the March meeting rolls around. If, then, the overall trends are what is important, can we find some consistency in the data of the optimists and pessimists? For this I turn to Table A12 of the employment report, a personal favorite of mine. Table A12 reports different measures of labor underutilization. The most optimistic measure is:
Percent of Civilian Labor Force Unemployed 15 Weeks & Over
The most pessimistic measure is:
Total Unemployed, Plus All Marginally Attached Workers Plus Total Employed Part Time For Economic Reasons, As A Percent Of All Civilian Labor Force Plus All Marginally Attached Workers
The headline unemployment rate at 4.9% basically splits the difference.
What do both of these pictures have in common? Both measures place labor market utilization near the rates seen prior to the great boom of the late 1990’s. Do policymakers believe that the late 1990’s can be repeated? Or was that period an aberration, and attempts to recreate that environment will only lead to higher inflation expectations?
I tend to believe that policymakers favor the latter interpretation. That implies if overall economic data points to stabilization in these measures, the Fed will be content to sit back after this next hike and wait to see how their medicine works. But if these measures continue to decline in concert with strong coincident and leading data, the Fed will feel obligated to move rates higher in March and possibly beyond. I believe this interpretation will not be well received by the labor market pessimists.
What about the employment to population ratio? PGL an Angry Bear points to a decline over the past five years as a sign of a weak labor market. This short run view of the data raises the same question: Was the push higher in the late 1990’s a reflection of a once-in-a-generation stock market boom? Do we really want the Fed to recreate those conditions? Do we really expect them to? And a longer run view raises another batch of questions:
Employment to Population Ratio
Here you are stuck with disentangling the cyclical behavior with the secular trends. If we attribute rising employment participation to increased female participation in the labor force, and if that trend has pretty much been maxed out while male labor force participation continues to slide, and we believe the boomers are starting to retire, then I am not sure we can expect much higher employment to population numbers short, again, of 1990’s style boom.
Similar thoughts can be said of Mark Thoma’s questions regarding stagnant numbers among marginally attached workers in the post below this one. You have to raise the question of what type of environment is necessary to draw these workers back into the labor force, and will the Fed attempt to do so?
Truth be told, I honestly don’t know the “correct” level for any of these measures of the labor market. Nor would I, or anyone at the Federal Reserve, say the job market is as strong as in the late 1990s. My point is that from a policy perspective, the last cycle may not be the relevant reference point. Pointing to the Clinton Era might be like pointing to the 1980’s in Japan – remember when Tokyo had all the answers? It was fun while it lasted, but it isn’t likely to happen again. If instead, we assume that the Fed sees labor markets as relatively healthy, and that they see this view as supported by rising wages (accelerating to 3.1% over the past year), then the next step for the Fed is to determine the impact on the inflation outlook. And that again raises enough questions to keep a central banker awake at night:
- To what extent do rising wages reflect productivity gains, tight labor markets, and pass through from this summer’s surge in headline inflation?
- How much of the wage gain will firms be able to pass through to core prices?
- Has past monetary policy already put enough tightening into the system to head off any pass through to core prices?
- What about the pressure exerted through rising commodity prices? Note that oil prices are creeping upward toward $70 again. Also watch metals (copper and gold).
- Is the housing market slowdown turning into a full blown bust?
With so many variables in play, it is not surprising that the Fed wants to change the game plan. To date, policy has been driven by the desire to normalize interest rates. But now that we are at a more neutral level, the next policy steps aren’t so clear. This is why policy is now data dependent, and why anything beyond Greenspan’s final move is fuzzy. [All Fed Watch posts.]
"We may be entering a period in which policy changes are even more dependent than they have been on current readings of the economy, with all the uncertainty such readings can bring,'' Minehan said. "As the Committee's minutes have suggested and its recent policy statement confirms, its communication is evolving.''
Fisher didn't speak in any detail about the near-term course of interest-rate policy. Minehan said policy makers will have to watch economic data to determine their next steps now that the Fed has removed most of the "accommodation'' from the economy. Investors should understand that Fed statements aren't going to give them a clear road map of future rate moves in that environment, Minehan said.]