Global Central Bank Focus

Telling (Taper) Time

​To decide when the Fed might begin to taper its asset purchases, closely monitor the Fed’s favorite labor market indicators.

To decide when the Fed might begin to taper its asset purchases, closely monitor the Fed’s favorite labor market indicators and consider two questions in particular. 

What is the purpose of the Federal Reserve’s asset purchases?

“The purpose of the asset purchases is to increase the economy’s near-term momentum, with the goal of improving the outlook for the labor market and helping to promote a self-sustaining recovery with price stability.” Fed Chairman Ben Bernanke, 20 March 2013

“The purpose of the new asset purchase program is to foster a stronger economic recovery, or, put differently, to help the economy attain ‘escape velocity’.” Fed Vice Chair Janet Yellen, 4 March 2013

Bernanke and Yellen speak to an economy that can make it on its own, without the assistance from the Federal Reserve, which it and markets continue to depend upon.

The failure to achieve “escape velocity” is why the Fed is using its printing press to purchase $85 billion of securities monthly. These purchases will continue, the Fed says “until the outlook for the labor market has improved substantially.”

What, then, constitutes a “substantial” improvement in the labor market outlook?

“It is a broad-based improvement in a range of indicators, as well as improvement in output and labor demand.” Bernanke, 20 March 2013

Bernanke, Yellen, and their colleagues list a plethora of labor market indicators, including these ten:

  1. The unemployment rate
  2. Monthly change in private-sector nonfarm payrolls
  3. Unemployment claims
  4. The duration of unemployment
  5. Aggregate hours worked
  6. The quit rate
  7. The hiring rate
  8. The employment-to-population ratio
  9. The labor force participation rate
  10. The “U-6” unemployment rate

That’s a lot of indicators!

Both Bernanke and Yellen emphasize that if any improvement in these indicators is to be sustained, economic growth must quicken. Job growth can’t be strong if economic growth is weak.

Yellen hones in on what might be the best indicator of them all: the unemployment rate. Citing Fed research, Yellen notes that,

“Since 1978, periods during which the unemployment rate declined ½ percentage point or more over two quarters were followed by further declines over the subsequent two quarters about 75% of the time.”

Still, Yellen and her colleagues believe that the unemployment rate has its limitations, which is why the Fed is looking at a wide range of indicators.

Progress
Let’s look more closely at a few of these indicators. While we do, keep in mind the excerpt below from the Fed’s March 20th policy statement. Note especially the highlighted portion (emphasis added), which was absent from the Fed’s previous policy statements:

In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.”

The key word there is “progress,” a word that Bernanke used frequently during his press conference when discussing the possibility of tapering the Fed’s bond buying, including in his opening remarks:

“The Committee could vary the pace of purchases as progress is made toward its economic objectives.”

Let’s now begin a quest for signs of progress in some of the Chairman’s favorite labor market indicators.

Figure 1 shows the unemployment rate, which remains elevated at 7.6%, a point Bernanke repeatedly makes. It is the driving force behind both the Fed’s bond buying and its zero interest rate policy. So, has there been progress of relevance to the Fed? Bernanke’s take: 

“Our projections for unemployment in the fourth quarter are noticeably lower than they were in September when we first announced our asset purchase program.” (Emphasis added).

In other words there has been progress. Yet, it’s not enough. Bernanke emphasized this, saying,

“We (do) need to see a sustained improvement. One month, two months doesn’t cut it.”

Bernanke’s comment makes clear that the April Federal Open Market Committee meeting is too soon for the Fed to consider tapering its bond buying, because by then the Fed will have only one new employment report in hand – the weak March employment report. In contrast, by the June 19th FOMC meeting the Fed will have three employment reports in hand to make a collective judgment, making that meeting potentially important. Mind you, given that the Fed has fallen short of its objectives on both employment and inflation, strong employment data and positive momentum in the economy are needed to compel the Fed to slow its printing press.

Figure 2 shows the monthly change in private-sector employment. Bernanke in his press conference took note, saying, “private payrolls are growing more quickly,” increasing by more than 200,000 per month through February. In fact, the average gain was 223,000, up from the previous year’s average of 183,000.



Five months does not make a trend, however, and the pattern in recent years has been for strength in the winter months to be followed by weakness. To wit, monthly payroll growth in the five months ended March 2012 was 250,000 before falling to 131,000 in the five months ended September 2012. Recognition of these ups and downs prompted New York Fed President William Dudley, who, along with Bernanke and Yellen are the leaders of the Fed’s wolf pack, to say, “we have seen this movie before.”

Importantly, Bernanke believes some of these ups and downs relate to the severity of the recession from 2007 to 2009, which caused the seasonal adjustment process to go awry. In his press conference he said the Fed believes the impact of these distortions “ought to be pretty much washing out by now. So if we do in fact see a slump, it would probably be due to real fundamental causes.”

In other words, if data weaken the Fed would take it seriously and therefore continue its bond buying, possibly increasing the purchases. On the other hand, if data strengthen despite the pattern of the past few years, it would provide compelling evidence of strengthening economic activity, giving the Fed the option to consider slowing its bond purchases.

The recovering housing market could prove instrumental for job creation in the months ahead. Construction employment increased by 49,000 in February, the most in six years
(Figure 3). Springtime weather could lend an upward bias to housing-related data.

Figure 4 shows the 4-week moving average for unemployment claims. Jobless claims by definition measure only the newly unemployed; only by inference are changes in employment derived. Nevertheless, the correlation between the level of unemployment claims and monthly changes in private payrolls is strong, making the claims data among the best and timeliest of labor market indicators. Watch it closely.

The hill still to climb
However there is another side to the story, told by indicators other than the most prominent ones, which, of course, are the ones Main Street understands best. While the Fed will likely still be biased toward the most prominent indicators, it will want to see progress in the other indicators it follows. Many show little or none.

Figure 5 shows one of these. It is the duration of unemployment, which measures the average number of weeks it takes the unemployed to find work. Chairman Bernanke has probably cited this indicator more than any other when describing the weak state of the labor market. Scant progress has been made. Nearly 5 million people have been out of work for six months or longer, an unprecedented number.

Figure 6 shows the employment-to-population ratio, which shows the extent to which job growth is keeping up with population growth. The ratio is a good gauge of the broadness of labor market strength (or lack thereof). Job gains that are small relative to the size of population growth will spell weakness in growth rates for personal income.

Figure 7 shows the “U-6” unemployment rate, an alternative measure of unemployment that captures the number of people who are working part-time but would rather work full-time, as well as the number of discouraged workers – people who have stopped looking because they cannot find a job. Roughly 8 million people are working part-time for economic reasons, more than a million above the previous peak in 1982.

Telling (Taper) Time
The seriousness of the unemployment situation is primarily what motivates the Fed to buy bonds. It hopes its bond buying will, as Janet Yellen said, propel the economic rocket ship to achieve “escape velocity.” Only when it has will the Fed begin to taper its bond buying.

The Fed has made progress toward achieving escape velocity but the progress must be sustained for the Fed to throttle back on its stimulus. The June FOMC meeting provides the earliest possibility for any decision, but it requires three collectively strong employment reports along with economic growth that holds up in the face of fiscal drag – a tall order, but not an impossibility given the recovery in the housing market and steady healing in the U.S. economy.

Investors need be alert for signs of progress in the many employment indicators the Fed is watching, and listen closely to what the Fed is saying to know when bond buying will be tapered.

The Author

Tony Crescenzi

Portfolio Manager, Market Strategist

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