This morning’s Nonfarm Payroll was not a great one — again — but as much as it was the less than stellar numbers themselves, it was probably more because it failed to deliver the much prized clarity that would have quickly eased market anxieties that growth might indeed be faltering.
*** The Federal Reserve, for its part, will be looking past this morning’s numbers as just too noisy to have any impact on its projections for the labor market and the growth outlook, nor will the NFP print alter the measured pace of the taper. And the drop in the headline unemployment rate to 6.6%, a whisker away from the 6.5% threshold, is at this point just plain irritating, more of a communications problem than a policy driver. ***
So with that in mind, here are our takeaways on the NFP and the upcoming Monetary Policy Report testimonies next Tuesday and Thursday, which will be the first by newly installed Fed Chair Janet Yellen:
* The Fed is highly likely to see the underlying labor market trend as still reasonably strong, pointing to net job creation revised up to 194,000 a month average last year. Even if the trend in the last three months looks to be softening, falling to an average 154,000, it will still take until at least the spring before it would be built into the forecasting projections.
* The net job creation was probably a bit lower than the Fed had been expecting, and even more surprising was the small upward revisions to the prior two months. But further upward revisions are still likely, and the labor participation rate ticked up, even if the headline rate again nudged ever closer to the 6.5% “not a trigger” threshold. But as we have previously noted, the threshold was already neutered by the “well past” sentence inserted into the December statement.
* As we noted above, the NFP number will not alter the current measured pace of Fed’s QE tapering. The Fed, after all, is only changing the mix of its ongoing very accommodative monetary policy. And even if the pace of growth was seen to be faltering, the bias in the policy response is likely to be on the rates side and the forward guidance rather than a pause in the bond purchases.
* We would expect Chair Yellen to take a reassuring tone in her testimony, offering a fairly optimistic outlook for growth, with lessening headwinds to the tailwinds of the underlying private sector strength driven by a steadily recovering housing sector, better balance sheets, still decent consumer spending and perhaps more business investment spending. She may even give a nod to Congress for getting out of the way by reducing the fiscal drag of the last few years.
* While acknowledging the EM turbulence, she is likely to assert it is nowhere near posing a systemic risk that would require an immediate Fed response; otherwise the Fed will be looking for its impact in the traditional real economy channels. Low inflation also bears close monitoring, but inflation expectations remain firmly anchored and will in due course steer under inflation back to target just as it pulls higher inflation in time back to 2%.
* Yellen is likely to take some criticism, especially in Tuesday’s testimony before the House Financial Services Committee, on the “swollen” balance sheet, the risks of inflation, or how the Fed “enabled” the Obama Administration to continue with reckless spending, etc. But Yellen is likely to easily address the concerns, reassuring the restive Congressmen that Fed is confident it has the tools to address the scale of the excess reserves in the system and to counter any inflationary pressures, however unlikely.
* The more interesting testimony is probably going to be on Thursday before the Senate Banking Committee, mostly because its smaller size may offer scope for longer answers to more probing questions. For one, even as QE is downplayed, Yellen may be pressed to explain the efficacy and risks in the alternative policy tool of the forward policy guidance that rates need to stay “lower for longer.”
* The reliance on low rates will also bring questions over the financial stability risks. It is in fact a simmering debate within the Fed system, but for now, the Fed Chair is likely to reply that the Fed is relying on close monitoring and numerous macro-prudential regulatory measures to dampen “excessive risk taking” before ever turning to the bluntness of interest rates before the real economy has clearly reached its escape velocity of self-sustaining growth.
* Yellen is testifying on behalf of the entire Federal Open Market Committee and can only go as far as the current consensus rather than her own views. In that sense, she will only be as “dovish” as the FOMC consensus is, which by the way, is still pretty damn dovish. A surprise, if there is one, may come in any elaboration or hints at how the FOMC intends to update its forward policy guidance.