The February payroll report was better than expected, better even than the ADP report suggested. Private sector jobs are growing at about a 2% rate, which is enough to bring the unemployment rate down over time. If productivity retains its long-term average growth of 1% per year (it was only 0.5% last year), this points to real GDP growth of 3%. That's not enough to close what I estimate to be the economy's 13% output gap, but it's sure better than stagnation.
February nonfarm payroll gains were much stronger than expected (236K vs. 165K), and private sector payroll gains were even stronger (246K vs. 170K), as the public sector continues to shed jobs. Since the low in early 2010, the private sector has generated 6.35 million jobs. We're still a long way from where we should be -- it would take maybe an additional five million to seven million jobs to put the economy back on its long-term growth track -- but the progress is undeniable.
Jobs growth in the private sector actually has been running at about a 2% rate on average for almost two years now, which is about the same pace as we saw in the mid-2000s.
The thing about this recovery that has been different from all others is the extremely slow rate of growth of the labor force: those who are either working or looking for work. As the chart above suggests, some five million to six million people have "dropped out" of the labor force, presumably because they have given up looking for a job. That explains a lot of the decline in the unemployment rate.
Regardless of whether the unemployment rate is understated (overstating the economy's health) or not, the fact remains that there has been a significant increase in the number of jobs over the past three years. Unemployment has clearly declined, and as usually happens during recoveries, government spending as a share of GDP has also declined. These are two very welcome developments. The recovery is proceeding in typical fashion, even though it's been a very sluggish recovery.
The stock market rally is fully justified by the ongoing -- albeit slow -- recovery in the economy. The chart above compares the decline in weekly unemployment claims (inverted, as a proxy for the economy's underlying health) to the S&P 500. Nothing unusual here at all. Claims are getting back down to "normal" levels, and the stock market today is only 2% shy of regaining its former high.
I don't think monetary policy has had much to do with the economy's recovery. The Fed has responded to the market's intense demand for safe-haven assets by buying $1.7 trillion of Treasuries and MBS, effectively swapping bank reserves (which are functionally equivalent to three-month T-bills) for bonds. They haven't "printed" much more money than usual, and the fact that inflation has not soared is good evidence that they haven't done too much.
But as the chart above shows, inflation expectations are now picking up. The difference between the yield on five-year TIPS and five-year Treasuries is now 2.58%, which is the market's expectation for the average annual inflation rate over the next five years. This measure of inflation expectations has rarely been this high since TIPS were first issued in 1997.
The chart above shows the yield on 30-year T-bonds. Note that since QE3 was officially announced in early November, yields are up about 50 bps. Yes, even thought the Fed has been buying bonds and trying hard to push long-term bond yields down, yields have instead risen. This is the paradox of Quantitative Easing: If it works (by stimulating inflation expectations), then it won't be able to do what it was intended to do (depress long-term yields). In other words, the Fed's failure to artificially depress long-term yields is good evidence that it has been successful.
It's becoming increasingly obvious that we no longer need more Quantitative Easing. QE3 is overstaying its welcome.