Fed Watch: Good News on Employment

Tim Duy:

Good News on Employment, by Tim Duy: With only a minimal drag from the government sector, the February employment report shined on the back of a solid gain in private sector hiring:

The last couple of months look more like the optimistic numbers seen early in 2011 before the mid-year slowdown raised the specter of another recession. As has been widely noted, there is little to complain about in this report. To be sure, in many respects we are still deep in the hole. Long-term unemployment remains a challenge:

Wage growth is meager:

And the employment to population ratio remains sits a levels not seen since the early 1980s:

Still, as noted earlier, these issues should be alleviated if job growth is sustained. And as a precursor to such improvements, the unemployment rate is falling, and at a reasonably quick pace:

What will this mean for the Fed? As I discussed earlier, the unemployment rate looked to be the weak link in the Fed's most recent forecast of 8.2-8.5% by year end. We are at 8.3% in January, and unless either waves of workers re-enter the job market or the economy shifts gears dramatically soon, we will be easily below 8% in just a couple of months. Under such a trajectory, I have to imagine that another round of QE, as well as the Fed's interest rate projection, are not sure bets at all.

To be sure, one can argue the Fed should seize this opportunity to entrench the recovery with more easing. After all, the employment to population ratio suggests plenty of slack in the labor market, as does minimal wage growth. And unit labor labor costs are moving sideways as well:

We know that at least one policymaker, Chicago Federal Reserve President Charles Evans, would already be easing much more aggressively, but we also know that others, such as Philadelphia Federal Reserve President Charles Plosser thinks the current rate outlook is not consistent with an improving economic environment. A couple of reports like this will find others in his camp as well.

I think it still premature to expect the Fed to dramatically shift forward their own expectations of a rate hike. That said, since the recession ended, Federal Reserve officials have tended to shift expectations away from more easing and toward tightening every time the data shows a little life, only to have to backtrack six months later when hopes are dashed. Assuming the Fed follows the same pattern, watch for a shift in tone from Fed officials.

I'm starting to wonder how the Fed will wiggle out of its interest rate commitment should the economy turn out to be stronger than the Fed's forecast. I still think the Fed needs to insure against potential problems -- it's far too soon to conclude our troubles are over, we're still in a deep, deep hole and a slower than tolerable recovery is certainly still possible, perhaps even likely -- but it does look as though there's a chance the Fed will have to reconsider its recent interest rate commitment ("exceptionally low levels for the federal funds rate at least through late 2014"). The FOMC does give itself an out by saying conditions are "likely to warrant" this policy, but it seems to me it has been interpreted as a pretty firm commitment. (Note: To be clear, I am not advocating interest rate increases any time soon -- I think the Fed is likely to pull the interest rate trigger too early rather than too late -- but given the Fed's inclination to raise rates sooner rather than later, how will it explain itself if that time to raise rates comes earlier than projected?)