The US Federal Reserve (Fed) said in June that it would begin to withdraw its quantitative easing (QE) programme later this year if unemployment figures fell in line with forecasts released at the same time. While this is on course, other data is below expectations, leading some analysts to question whether tapering will begin in September as expected.
The only figure in line with Fed forecasts is the unemployment rate which fell to 7.4% in July from 7.6% in June. August 2 data showed that non-farm payrolls rose 162,000 last month – less than the consensus. This dampened expectations that the Fed will start to scale back QE, according to Jessica Hinds and Paul Ashworth, analysts at Capital Economics.
The Fed has suggested that its decision on whether or not to taper in September depends on non-farm payroll growth remaining in the 175,000 to 200,000 range until the end of the summer.
“While today's report missed the range by a narrow margin, the three and six-month averages are still well within it at 175,000 and 199,000 respectively. Importantly, the break-even speed is currently estimated between 80,000 to 90,000 jobs per month. So, maintaining this pace will continue to put significant downward pressure on unemployment,” said Aneta Markowska, senior US economist at Société Générale.
“There is one more employment report between now and the Sep FOMC [Federal Open Market Committee] meeting. And, if the latest drop in initial jobless claims is any indication, it should be a solid one. Therefore, while we acknowledge that today's data was disappointing, we maintain our call that the Fed will begin to scale back asset purchases at the upcoming September meeting.”
However, the FOMC statement contained some dovish tones, which have softened some expectations of when tapering might start, said Brian Hilliard, chief UK economist at Société Générale. In particular, there was some unease about the low level of inflation, with the committee admitting that if inflation persists below its 2% objective this could pose risks to economic performance. Inflation was at 1.8%.
“Moreover, the economic assessment was slightly downgraded with growth now described as modest rather than moderate. The Fed is a little worried about the impact of the higher yield trend, which results from its own signals, on the housing market,” he said.
“So to see the commencement of tapering in September will require the confirmation in the data of our view that the housing market will prove resilient in the face of higher mortgage rates.”
A lucky escape
Others are less forgiving in their analysis of the data and commentary provided last Friday.
“The Fed is wading into some pretty uncomfortable territory. Back in June, it said QE would likely be tapered later this year if the economy progressed in line with the Fed forecasts released at the same time. The unemployment rate... was the only good news in Friday’s labour reports and part of that was for the wrong reasons,” said David Carbon, economist at DBS in a July 5 note.
“Another 37 thousand workers dropped out of the labour force in July, raising the share of Americans not participating in the labor force to 36.6% – the highest in 35 years, save only for May’s 36.7% share. Other parts of the labour reports were also discouraging. Hourly earnings fell. The workweek fell… Is this the improvement in labour markets the Fed is looking for? Of course not.”
However, the Fed has largely attached its communications about tapering to the unemployment figure, and this is the one that has been falling fast. If it is not careful, it will have to begin pulling back its QE programme in September regardless of whether the US is recovering or not, according to Carbon.
“How [will it] get out of that one? The obvious way would be to say that GDP growth is not progressing anywhere near Fed forecasts laid out just last month. The past three quarters’ growth has averaged only 1% quarter-on-quarter, and the past four quarters are barely any better at 1.4%,” he said.
If Fed expectations of 2.45% year-on-year in the fourth quarter are to be reached, sequential growth of 3.4% quarter-on-quarter is required over the next two quarters. Forecasting is tricky business. The Fed’s GDP forecast might just be the lucky mistake that lets it off the unemployment rate hook it now hangs from.”
Others agree that the Fed may need to reconsider its exit from easy monetary policy. One impact of Fed chairman Ben Bernanke’s comments to congress in June was much higher bond yields. This has become an increasing concern for the US de facto central bank, said Gary Dugan, chief investment officer for Asia and the Middle East at Coutts Private Bank.
“By adding more worries to its list, the Fed has in effect made it more difficult to work out its next move. European policymakers are trying hard to bring down long-term interest rates and assist economic recovery by adding clarity and direction,” he said.
“The Fed appears to have done the opposite. Its decisions appear more dependent on volatile data points (that are often heavily revised) than a well thought-out exit plan.”