No way around it, this morning’s Non-Farm Payroll numbers were seriously good, pointing to a steady-looking improvement — we want to say a “substantial” improvement — in the labor markets over the previous three or six months. It makes it more than a bit difficult to justify the need for the equivalent of still cutting interest rates with the additional accommodation each month in the ongoing bond purchases.
Against the backdrop, there are two takeaways for us in this morning’s solid looking Non-Farm Payroll numbers when weighing the Federal Open Market Committee’s December 17-18 meeting:
*** First, the FOMC’s decision when to make that long awaited first downward adjustment in the flow of the $85 billion a month in bond purchases has now been narrowed down to a purely tactical one of either the December or January meetings, and second, that the decision will be driven less by the external developments with data and the projections and more by how the internal consensus is achieved in the trade-offs and communications on the taper timing and amount and the language used to reinforce the forward guidance on rates. ***
*** So we still suspect the caution to avoid undesired volatility in year-end markets and to give the broader markets time to adjust to the coming adjustments in QE points to an actual first taper in January. December is likely to focus on providing a clearer path to winding down QE, with a first taper “soon” and ending by mid-year with a total tally of around $1.2 trillion and a primary accent on the reinforced rates guidance, and in particular, why rates can stay lower for longer and the eventual tightening can be very gradual even as growth and employment are back to trend. ***
A Still Cautious FOMC
A window that is narrowing down to but two meetings stands in stark contrast to the “QE forever” expectations of just a month ago or so. We were pushing hard against the excesses of that QE forever chatter at that time (see SGH 10/30/13, “Fed: Framing December,” and SGH 11/20/13. “Fed: Towards a December Consensus”), and we are now pushing back again, perhaps with less passion to be sure at this point of fine-tuning, against the market flipping too hard now in getting juiced up specifically over a December first taper.
A December taper would be great in terms of finally getting the darned thing started, especially if the trading market pricing seems to be suggesting it is there for the taking. And if the FOMC is ready to all but broadcast they are ready to taper, why wait? And after all, a decision to hold off but nevertheless flag a potential imminent move in January would be tantamount for markets to getting the process going anyway.
But the better question is we think why rush? If the stage is set in December, it will still be or even more so in January. Recall, as we wrote in our last report (SGH 11/26/13, “Fed: On Thresholds And The Taper”), there are essentially two triggers to the start to the great QE wind down: a minimal disruption in the markets, and most of all, a greater degree of confidence in the projections for a more broadly-based and sustained-looking recovery that points to a near term “escape velocity” in the pace of growth.
On both counts, we suspect the conclusion around the table at the December meeting will be “almost” rather than checking the box on either.
On the first, for an ever cautious FOMC, it must take into account the broader markets, how long it may take real money accounts, not to mention the emerging market flows and policy responses, to position for a lower flow of Fed purchases. The consensus, we think then, on this front is more likely than not to fall on the merits of allowing for more time for buyers to step in to replace the Fed bid to minimize volatility at the long end while keeping the short end firmly anchored as the Fed builds on the credibility of its rates guidance.
And if not taking up a taper purely on account of a market that seems ready for it, there is nothing to be lost and everything to be gained with another month to see how the data settle on the real economy after the turn of the year – in particular, the trend in aggregate demand and the pace of consumer spending (and there are retail sales numbers just prior to the December meeting).
Again, the critical calculation is not the most recent data points, however strong, or even the central tendency forecast that emerges in the Summary of Economic Projections to be updated at the December meeting; instead it is the degree of confidence in just how sustainable the better-looking numbers are.
And while March may be too distant — put up or shut up essentially — January is going to offer that extra degree of comfort that after this long hard slog of a sub-par pace of recovery, the elusive escape velocity is finally in sight.
A 7% Rate and the Threshold
Perhaps the most intriguing aspect of the NFP is the surprising drop in the headline unemployment rate to 7% — a full six months ahead of Chairman Ben Bernanke’s scenario presented last June. On the one hand, many might assume that makes it a given the Fed will lower the now year-old unemployment threshold from 6.5% to 6% or lower.
But more likely, we think, it will make the FOMC conclude the headline rate is losing even more of its reliability and credibility as a useful guide to policy at this stage of the recovery; all the more reason then, as useful as the threshold has been in guiding expectations on policy through what will be its one year anniversary, to offer a further evolution in the intended threshold guidance by laying out the wider array of indicators of a sustained labor market improvement like average hourly earnings, hires and fires rate, etc. that will guide policy once the 6.5% threshold is crossed.
Indeed, we suspect the guidance issue, which of the options on the table to reinforce it and to keep the short end well anchored, will dominate as much of the discussions on the 17th and 18th as the timing to the taper.
In particular, the FOMC is searching for ways to enhance the credibility of the lower for longer rates and especially the slower for longer trajectory in perhaps phrasing in a single sentence how the need to get to a neutral fed funds level can lag by a year or more when it projects both growth and unemployment to reach their desired trend levels.
It is, in effect, a major call on inflation and the level of appropriate policy over a three year horizon of the forecast — which will show up in where those dots for the 2016 year-end fed funds rate tend to cluster — and it may prove as difficult to get to a consensus on that as it will be on the December versus January first taper decision.
One last thought is that if the consensus does come together for a tapering path — that is, barring a sharp reversal in the recovery — would there be any point to one last dissent for the year from Kansas City? A year-end statement with no dissents might have just as much of a desirable impact on market expectations as anything else the FOMC does.