I drew back from blogging for the past couple of weeks to clear my desk, a task that will not be complete until next week. Seemed like an opportune time, as the focus had shifted away from the Federal Reserve to the fiscal train wreck, in the process putting monetary policy on indefinite hold. Federal Reserve hawks clearly lost whatever leverage they had heading into the September FOMC, and any thought of changing policy in October disappeared long ago. I wrote earlier this month:
It's not just difficult to explain a cut [in asset purchases] in the coming months. It just isn't going to happen. Stronger data? We no longer have any of the most important data. Swift resolution of fiscal uncertainties? That battle is even bloodier than that within the Fed. Moreover, the impending leadership change also argues for delaying tapering until 2014. Unless the economy lurches upward, what exactly is the reason to pull the trigger on tapering before the March FOMC meeting, after which future Chair Janet Yellen will lead a press conference? None, really.
The September employment report further cemented the idea that March is the next opportunity for an change to the asset purchase program. I am glad that I did not get out of bed early for that report. I am not exactly sure it was worth the wait. Rarely does one encounter such a lackluster mound of data, summed up in the pattern of flat-lining of job growth:
Placed in context ofthe Yellen charts:
With the exception of the unemployment rate, it is difficult to see signs that labor market momentum has definitively shifted toward "stronger and sustainable." As for additional labor market indicators:
Only the recent uptick in wage growth gives hope that something more positive might be happening underneath the surface of the data. Shifting to measures of unemployment, though, leaves one less optimistic:
Overall, it is difficult to image that the data suddenly surges upward to justify a shift policy shift in the near term. And even the focus on March is suspect - more likely an artifact of leadership transition at the Fed rather than anything else. Consider that the data will be murky for the next few months. Then maybe we see the data improve, assuming fiscal policymakers do not tighten policy further. And then, if the Fed doesn't change its tune, we need a few more months of data to define that improvement as "sustainable." So it is easy to see the current pace of asset purchases continuing well into next year.
What could change that picture? There remains a contingent within the Fed concerned with issues of easy policy driving financial instability, and that contingent will have a larger voice with Dallas Federal Reserve President Richard Fisher and Philadelphia Federal Reserve President Charles Plosser becoming voting members. Moreover, President Obama could choose candidates biased against asset purchases to fill open spots on the board. Barring any change in the flow of data, it would need to be financial stability concerns that drive a decrease in the pace of asset purchases, but such concerns remain more ephemeral than specific at this point.
I imagine one could construct an argument linking together the falling unemployment rate and accelerating wages gains as a signal that the labor market has turned upward. This seems like a thin argument and requires that the Fed throw remaining labor market indicators overboard. But downplaying the decline in the unemployment rate leaves the Fed with another communications challenge. The 6.5% unemployment threshold is looking pretty silly at this point. Indeed, it is reasonable to believe that the unemployment rate approaches to within a hair of 6.5% over the next several months before the Fed has another opportunity to cut asset purchases. The Fed really needs to change the 6.5% threshold. It already seems meaningless, and will only become more so. Gavyn Davies is right on this point.
Bottom Line: Incoming data are not exactly consistent with the definition of "stronger and sustainable." And even if the data shift upward in the next few months, it will take another three months to confirm that it is sustainable. That pushes any decision on asset purchases out to March at the earliest. If the Fed wants to taper sooner, policymakers will need to hang their hats on the unemployment rate alone, which seems unlikely. In the meantime, the one-way direction of financial markets will drive the "financial stability hawks" on the FOMC crazy, but at the moment they lack sufficient numbers to push forward their campaign to end asset purchases.
