Friday, April 4, 2014

Five Reasons to Temper Fed Hike Expectations

Structural weak spots in the US labour market may be more entrenched than the market currently thinks they are.

Federal Reserve Chair Janet Yellen Photo credit: AFP Photo
US economic numbers continue their lukewarm return to pre-freeze levels. The service sector Institute for Supply Management (ISM) survey rose by a point and a half in March but, like the manufacturing ISM and the ADP jobs reported earlier this week, the 53.1 outcome remains well shy of November levels. Two months after the weather has returned to normal, the data have yet to show any signs of snapback that would normally follow "technically" depressed levels.
Will non-farm payrolls and the unemployment rate be any different Friday? Markets look for 200,000 March payrolls, which would also fall into the lukewarm category. A 300,000 number would be "normal" if hiring was depressed for weather or other technical reasons.
The unemployment rate is expected to drop by another tick to 6.6% but as Federal Reserve Chair Janet Yellen noted in a speech this week, the official rate isn’t a good indicator of labour market strength right now. She offered five reasons why this is so and why the Fed is backing away from the 6.5% threshold for lifting policy rates. Normally, when someone gives you five reasons for something, you’re not sure if they’re trying to convince you or themselves. In this case, though, Yellen’s reasons are worth recounting.
First, she noted, there is a lot of part-time employment. Nearly 20% of those lucky enough to have jobs are working part-time – the long-run average is closer to 16%. Turnover is slow, she added – no one with a job is moving on to better things, they’re all clinging to their life-rafts. Wages aren’t going up, either.
Not for nothing is core PCE inflation – the Fed’s favoured gauge – running at 1.1% rather than the Fed’s 2% target. And it’s falling, not rising. Some at the Fed actually prefer the "market based" PCE deflator, because it takes out the (theoretically imputed) cost of rentals / housing. Inflation in that measure (of actual market transactions) is down to 0.7% on-year.
Fourth, the share of the long-term unemployed (six months or more) is still running at 37% of the total, some 22 percentage points higher than historical average. This is the danger that former Fed Chair Ben Bernanke spoke of back in August 2012 when he flagged the arrival of the third round of quantitative easing. Many long-term unemployed (currently 3.8 million workers) will become permanently unemployed, representing a huge cost to society in terms of lost output and social disintegration.
Finally, Yellen noted what everyone has been noting for the past few years: the labour force participation rate is at a 35-year low. Can this be sloughed off to retiring baby-boomers? No, says Yellen: the participation rate is down among all age groups, not just on average.
It’s a long list that we often summarise in a single chart (below). The proportion of working-age Americans with jobs is barely any higher today than it was at the nadir of the crisis four years ago. By this estimate, labour markets have recovered one-third of their lost ground. It’s not nothing but it’s certainly not impressive. The two-thirds that remain below water represent nearly nine million workers, a population almost the size of New York City. That’s a lot of slack and as Yellen notes, it’s not being mopped quickly enough.
At the current rate of recovery, it would take another eight years for labour markets to return to normal and, the textbooks would say, for inflation to start rising.
Zero interest rate policy in 2022? Don’t rule it out.