The Fed Will Taper In Baby Steps

by: Vahan Janjigian, CFA

Last week's economic data was mixed. Both the ISM manufacturing and non-manufacturing (i.e., services) indices came in at stronger-than-expected levels, initial jobless claims came in at a better-than-expected 323,000, and vehicle sales surged to 16 million on a seasonally adjusted annual basis. Vehicle sales are now back to where they were before the financial crisis of 2008. One major difference, however, is that more people are leasing vehicles now than they did before the crisis.

Things were looking so good on the economic front that the 10-year Treasury jumped up to 3% as investors became convinced that the Federal Reserve's long-awaited tapering was about to commence. Then the Bureau of Labor Statistics released its closely followed Employment Situation for the month of August. To put it bluntly, the results were dismal. They were so bad that the 10-year Treasury immediately backed down to less than 2.9% as investors began to wonder if the Fed would delay tapering. The 10-year Treasury eventually settled at 2.94% for the day.

According to the Household Survey, the unemployment rate improved slightly to 7.3% from 7.4%, which one would think was good news. Unfortunately, once again, the improvement was not due to higher employment, but to more people giving up hope of finding a job. The number of unemployed persons fell by 198,000; but the number of employed persons also fell by 115,000. In other words, the civilian labor force shrank even as the civilian non-institutional population increased. This caused the participation rate to plummet to 63.2%, its lowest level since August 1978.

According to the Establishment Survey, nonfarm payrolls increased in 169,000 in August. That was considerably less than the consensus expectation. Yet that wasn't the worst of it. The July nonfarm payroll figure was revised from an increase of 162,000 to an increase of just 104,000; and the June figure was revised from an increase of 188,000 to an increase of 172,000. In other words, there were 74,000 fewer jobs created in June and July combined than the BLS initially thought were created during those two months. Combined with August's weak number, the employment situation is turning out to be much more anemic than most economists had expected. Furthermore, the jobs that are being created are not particularly good ones. They are not the high-paying jobs one would hope to see in a strong economic recovery. Instead, the gains are coming in areas such as health care, retail trade, and food services and drinking places.

Ben Bernanke and his cohorts are studying all the numbers carefully. No doubt they are encouraged by the ISM indices and automobile sales. Even though they like the improving unemployment rate, they must realize that the gains are largely illusory. Nonfarm payrolls are still much too weak and the jobs being created are not the ones that will put much money into workers' pockets. Still, quantitative easing can't go on forever. The long-awaited tapering will begin, but it looks more and more like the Fed will proceed in baby steps. I can't imagine that the Fed will taper by more than $10 billion per month to start.