The pace of job growth in the United States threatens to continue to delay economic improvement. At the same time, the Federal Reserve has established employment as the most important barometer it will use to determine when to begin tapering off quantitative easing, or QE3 — the Fed’s massive bond-buying program. We now face a seemingly impossible situation in which slow employment growth will prevent economic growth, while improving employment will force the Fed to pull the plug on stimulus.
The following table summarizes employment gains over the past 13 months in thousands. As can be seen in this data, with the exception of November, December and February, we have struggled with job growth below 200,000 new jobs created per month. In fact, the average monthly growth has been 172,000 over the past 13 months. Since the sequester spending cuts went into effect on March 1, job growth has averaged 155,000.
The Fed has stated that it needs to see at least 200,000 jobs added for at least four months in a row before it will begin to taper off QE3, the asset-buying program through which it has been buying $85 billion in bonds each month for the past eight months.
“We cannot live in fear that, gee whiz, the market is going to be unhappy that we are not giving them more monetary cocaine,” Richard Fisher, president of the Federal Reserve Bank of Dallas, said on June 5.
There is clearly dissention in the Fed’s ranks, as several Fed representatives have recently made similar comments regarding the timing of the beginning of the end to QE3. Some, like Fisher, are calling for an immediate end to stimulus, while others believe it should continue until we gain at least the 200,000 jobs per month for at least four months. Still others are calling for a calendar-based schedule, with the Fed’s bond buying to begin to taper off by September.
Recent comments from Fed Chairman Ben Bernanke have emphasized the Fed’s willingness to ramp back up its bond buying after the tapering off begins, if the economy shows new signs of weakness. Clearly he wants to send a strong message that the Fed has the flexibility and the determination to do whatever is required to nurse the economy along, if growth is compromised by the removal or reduction of stimulus.
When the Fed meets June 18-19, all eyes and ears will be on the official statement released after the meeting, the minutes produced from the discussions, and any speeches given by Bernanke and other Fed governors. It is certainly possible that the Fed could decide to begin tapering off its bond-buying program at this meeting. It is more likely, however, that discussions on a more specific schedule for tapering will gain intensity as Fed governors in favor of ending QE will become increasingly vocal.
The risk the Fed faces by continuing to inject so much cash into the economy is sparking inflation. By pumping hundreds of billions of dollars into the economy, the Fed risks weakening the dollar, and thus causing inflation to increase, which can be devastating. Historically, the Fed has been willing to take drastic measures to thwart inflation, even at the cost of driving the economy into deep recessions. The last thing it wants to do is to purposefully and deliberately cause out-of-control inflation.
At this point it seems highly likely that the Fed will begin to decrease stimulus very soon, regardless of employment growth. Its challenge will be to do this at a pace that is rapid enough to prevent inflation without stifling economic growth and causing unemployment to actually increase. Walking this economic tightrope will perhaps be the most daunting challenge the Fed has ever faced.
Financial markets have already begun to react to the possibility, or the inevitability, of the end to QE3. We have already seen interest rates rising fairly dramatically, including mortgage rates, with bond prices dropping despite the continuing bond buying by the Fed. Selling in bonds will certainly intensify once tapering begins, accelerating the rise in rates.
Stocks so far have been resilient, although other markets, and especially Japan, have already begun correcting under pressure from the possibility of Fed tapering. Japan has already dropped 17 percent from its May 22 all-time high, with that market showing serious signs of further declines. It is very likely that the U.S. stock market will also correct dramatically and violently, once the Fed establishes a schedule for tapering, and certainly by the time the Fed actually begins to slow its stimulus activities. It will be interesting to watch the reaction of the stock market as we approach the upcoming Fed meeting.