Monday, September 10, 2012

US jobs data makes more Fed action a done deal

When a Federal Reserve Chairman articulates “grave concern” about the weakness in the labour market and that comment is followed by weaker than expected jobs growth, further Fed action must be close to a done deal.  All that’s left to consider is what form said action might take.

August payrolls data was disappointing.  Market expectation was for a payrolls increase of +130k: the number printed at +96k.  To add to the disappointment revisions knocked 41k off June and July.  The separate household survey showed the unemployment rate declined to 8.1% in August from 8.3% in July.  That was driven primarily by a drop in the participation rate from 63.7% to 63.5%.

The Federal Open Market Committee is therefore almost guaranteed to do something when it meets later this week (Sept 12/13th).  While action is close to guaranteed, it remains to be seen what form that action might take.  The easy option, and least aggressive, is to use its communication policy and signal an extension to the “extended period” over which interest rates will remain low.  The current guidance is late 2014; they could easily shift that out to 2015.

They could opt to be more aggressive.  We’ve previously put the odds of more quantitative easing at 50:50 with changes to those odds dependent on how activity, and particularly labour market, data pans out.  Given the recent data the odds of QE3 being announced this week has risen to 75%. 

Why not 100%?  The Committee could choose to wait for more data.  As we’ve said before, much of the current slowdown in global activity is Europe-related.  The ECB has only just announced its Outright Monetary Transactions plan.  We think that will go a long way towards reducing financial tensions in Europe and improving global business confidence.  It also seems reasonable to assume that fear of the “fiscal cliff” is delaying hiring and investment plans in America.  The Committee might keep its powder dry and see how fiscal policy plays out.  Having said that, we know fiscal policy will be contractionary next year, we just don’t know how much.  The Committee might take the view that any fiscal contraction next year warrants further monetary policy action now.  The final reason they could wait is the fact that the second tranche of “operation twist” runs through to the end of this year.

If we get QE3 this week it’s unlikely to be in the same form as QE1&2.  Asset purchases are likely to be focussed on Mortgage Backed Securities, with speculation also that the Fed may opt for an open-ended program with no quantum or time-frame announced.