7.0% unemployment makes tapering in December more likely

Today’s commentary

Today is the day when the much anticipated jobs report was released. And the data were good. The jobs report was not the big news in my view, however, because at the same time we saw the jobs numbers we also got personal income numbers – and they were weak. These numbers point to why the economy is not growing more quickly. yet the Fed nears its 6.5% threshold. Below I have some thoughts.

Let’s start with the jobs numbers. The headline figure was the 7.0% unemployment number. That was a big jump down from the prior month’s 7.3% and puts the unemployment number within clear reach of the 6.5% unemployment threshold the Fed has set for hiking rates. Below I want to go into why these numbers are not so great. But before I do, I think it bears mentioning that this is exactly why the Fed is in a bind over its forward guidance. The 6.5% unemployment threshold was an error. We are approaching that threshold quicker than the Fed anticipated –  and this without the economy on really solid footing. How can 6.5% possibly be the rate at which the Fed starts thinking about hiking? They haven’t even started tapering large scale asset purchases yet. So 6.5% is now meaningless, forcing the Fed to have to come up with a new plan. The big news in today’s jobs report is that it makes the Fed’s conundrum on how to conduct forward guidance that much more important.

If we look at the data, it was an OK report. We see non-farm payrolls adding 203,000 jobs with 196,000 of them coming from the private sector. That beats consensus forecasts of 180,000. Interestingly, the figures also mean that government employment is no longer a drag on the employment numbers. We are now also just 1% below the pre-recession jobs level. We also see that the Labor Participation rate measured using the household survey rose to 63.0% from 62.8% despite the large decline in the unemployment rate. Average hourly earnings rose 0.2% but the year-on-year increase is just 2%.

Calculated Risk notes that, “[r]etailers hired 471 thousand workers (NSA) net in November.  This was just below the level in 2012, and suggests that retailers expect decent holiday sales.” Yet, we know that retail numbers have been weak and that most of the net increase in Q3 GDP estimates came from inventory building, ostensibly in anticipation of stronger retail numbers. I don’t know where these expectations are coming from. We see them in the new orders subcomponent for the ISM survey. If this number stays strong, perhaps we are going to see some inventory builds in this quarter as well, making the post-holiday inventory purge particularly nasty for retailers, with the concomitant effect on seasonal hiring.

The income data and the retail sales numbers do not support these inventory builds in my view. Personal income decreased 0.1% and disposable personal income (DPI) decreased 0.2% in October, according to the data released at the same time as the jobs report. On a year-on-year basis, however, personal income is up 3.4% where as disposable personal income is up 2.6%. That is decent growth to support retail sales but there is the risk that retailers are getting ahead of themselves. The bargain hunting during the holiday retail season suggests that the increase in retail sales will be muted. Let’s wait and see.

My analysis then says that we have a Fed that is committed to tapering QE now or within the next three months and then to moving to a tightening bias when unemployment falls below 6.5% sometime in early-mid 2014. Meanwhile job growth is in the 200,000 monthly range, jobless claims are at cyclical lows of 320,000 per week and disposable personal income is up about 2 1/2% over the last year. With the sequester cuts coming early next year, that gives the US a 2%-ish growth trend. I would call this escape velocity but nothing to write home about. The real question is how the Fed decides to backtrack on its forward guidance and what impact this backtracking will have on asset markets, especially housing.

I would not be surprised if the Fed tapered this month and then changed its forward guidance to divorce interest rate policy and quantitative easing in a way that sends as accommodative a signal as possible. The recent data say the Fed cannot wait. With the unemployment rate at 7.0% already, the need to move the forward guidance is that much more urgent. The Fed does not want to wait until the 6.5% threshold is right on top of us. And given the Fed’s desire to taper at the same time, it tells me the Fed should taper asset purchases in December.

P.S. – It really isn’t clear how fast the pace of hiring is coming along. This tweet by Greg Ip encapsulates the data problem:

Critical mystery. (1) Non-farm payrolls up 2.3m last 12 mos; household employment adjusted to NFP definition, just 1.3 m. Which is right?

— Greg Ip (@greg_ip) December 6, 2013

I suspect we will know better by February or March whether we have lift off in the US or more limp along growth. Much of this will be tied to how the holiday season goes for retailers and whether there are excess inventories to work off come January.