In May, Federal Reserve Chairman Ben Bernanke mentioned the potential for the Fed to begin tapering their asset purchase program, Quantitative Easing (QE). Since then, the financial markets have been obsessed with tapering and - more specifically - how it may affect interest rates.
Many Fed watchers have predicted the Federal Reserve will begin to taper QE sometime in early-to-mid 2014. After the latest jobs report, there is talk that the Fed may reduce asset purchases sooner rather than later.
On December 6th, the Bureau of Labor Statistics released the November jobs report, which showed nonfarm payroll employment grew by 203,000. The jobs numbers were significantly better than expected and lowered the unemployment rate sharply from 7.3% to 7.0%.
The seemingly good economic news propelled the stock market higher. That same day, the Dow Jones was up nearly 200 points and the S&P 500 rallied back up above 1,800.
The positive job numbers led many to forecast a QE taper starting at the Fed's last meeting of 2013. Will the Fed start to taper in December? Probably not. Here's why:
1. Data Not Quite There
When Bernanke first mentioned QE tapering back in May, he cited needing to see a 4-month average of at least 200,000 of weekly job growth to justify reducing the pace of asset purchases. The chart below shows the nonfarm payroll data since January 2013.
|Figure 1: 2013 US Non-Farm Payrolls & Unemployment Rate|
From April to July, the 4-month moving average was just over 172k. After November's numbers, the 4-month average moved up to 176k. While the trend is certainly positive and increases the likelihood of a Fed taper, the data is still not near the trigger point that Ben Bernanke stated back in May. We have said all along that the decision to taper would be data-driven and we still stand behind that.
2. Participation Rate Falling
The participation rate measures the active portion of labor. It only includes the number of people that are either currently working or pursuing work - eliminating those who are no longer actively searching for jobs. The chart below graphs the participation rate from 2003 to 2013.
|Figure 2: US Participation Rate Since 2003|
From 2003 to 2008, the participation rate fluctuated around 66%. Since 2009, it has fallen to 63%. In 2013, the participation rate has dropped farther from 63.6% in January to 63% in November. With less people participating in the workforce, the unemployment rate is artificially reduced.
If the unemployment rate had remained constant, the unemployment rate would currently be 7.8% - much higher than the current 7.0% level and much farther from the Fed's trigger point of 6.5%. The Fed knows this and we don't believe they will start to tighten monetary policy until they see real economic improvement.
3. Deflationary Fears
As we discussed in our post about the economy, the Fed is much more concerned about the possibility of deflation than it is about inflation. October's core inflation rate was 1.68%, down from 1.76% in August. With core inflation well below the Fed's target of 2 to 2.5% and trending lower, it is unlikely that the Fed will decide for an early taper.
With low probability of a Fed taper and no inflationary pressure, we expect interest rates to stay muted headed into 2014 and don't see any significant movement in rates until at least 2015. The bond market's reaction to the better-than-expected jobs data seems to indicate that fixed income investors agree with us. In two days of trading following Friday's report, the 10-year U.S. Treasury yield dropped from nearly 2.9% to under 2.8%.
Without any major upward tick in long-term (10+ year) interest rates, investors still have very few places to put money. Price-to-earnings ratios are well within historical norms, especially considering we are in such a low interest rate environment. As rates continue to stay low, we anticipate cash on the sidelines and in fixed income will continue to move towards equities. While investors are unlikely to see another year like 2013, continued low interest rates and improving global economies will keep the bull market alive in 2014.