Apologies to ZZ Top, but payrolls Friday usually gets me thinking about that song. Sometimes we get nonfarm payrolls and unemployment rates that offer clarity about the changing role of labor in the economy. Sometimes we get a release that raises more questions than it answers. Today’s report was the latter.
The Federal Reserve Act of 1977 assigned the Fed the responsibility for promoting “the goals of maximum employment, stable prices, and moderate long-term interest rates.” This is commonly referred to as the “dual mandate,”[i] and it is clear that maximum employment is the first goal mentioned. Chairman Powell and numerous Fed governors have told us repeatedly that they will not raise rates until we reach full employment. Having acknowledged that the Fed’s inflation target has been largely met, investors must now look for clues as to whether the conditions exist for the Fed to believe that full employment has been achieved.
One problem is that the Fed hasn’t actually told us how they define maximum employment. The Bureau of Labor Statistics (BLS) defines full employment thus:
BLS defines full employment as an economy in which the unemployment rate equals the nonaccelerating inflation rate of unemployment (NAIRU), no cyclical unemployment exists, and GDP is at its potential. The full-employment assumption links BLS projections to an economy running at full capacity and utilizing all of its resources.
Unfortunately, we don’t know if that is the same rubric used by the Fed. And even that definition is open to interpretation since it is hard to say when GDP is at its potential. We can assert that we’re not all that far off from meeting some of those conditions. The unemployment rate was reported as 4.8% while average hourly earnings grew 4.6% over the past year. We may still see pockets of cyclical unemployment, but we are also hearing constantly about jobs going unfilled. Last quarter, GDP grew at a robust 6.7%. It is probably too early for the Fed to say, “mission accomplished”, especially given their bias towards over- rather than under-accommodation, but we need to be considering how close we are to accomplishing the goal of full employment.
Bear in mind, however, that meeting the dual mandate is the Fed’s goal for raising rates – not it’s goal for tapering bond purchases. After the last FOMC meeting, Chair Powell explained that we are unlikely to see higher rates before the Fed completes its bond purchases. He indicated that tapering should be finished by mid-2022 and that interest rates are unlikely to rise much before the end of that year. Yet some people questioned whether today’s report could delay the start of Fed tapering. Along with many economists, I believed that anything short of a catastrophic report would not cause the Fed to deviate from its perceived desire to begin tapering after the November FOMC meeting (less than a month away). With 5-30 year rates tending between 2-4 basis points higher, it seems as though government bond traders agree.
Stock traders are a bit more confused, though. The S&P 500 Index (SPX) has meandered around unchanged levels, while the NASDAQ 100 Index (NDX) is trading slightly lower. Remember, an inverse trading relationship has developed between the 10-year yield and NDX. Even though long-term rates have little direct influence on tech stocks, their valuation tends to decrease as rates increase (and vice versa). In a recent Barron’s article, I asserted that investors are trying to reckon with the apparently changing monetary and fiscal environments, and while uncertainty can lead to volatility – like we experienced recently – that same lack of conviction can lead to market paralysis. If no one is sure what to do, sometimes they choose to do nothing.
My takeaway is this: today’s payrolls report told us a decent story about the labor economy. While the headline number missed estimates substantially (194,000 vs. 500,000 expected), a positive revision shrank the miss to only 137,000. When we consider that the total US labor force is over 160 million, we are talking about differences that represent only a tiny portion of the entire labor economy. And when we see the unemployment rate dropping to 4.8% from 5.1% along with a 4.6% rise in average hourly earnings, it is very difficult to see anything that would cause the Fed to deviate from its tapering path. Traders and investors need to figure out whether their holdings and risk management remain appropriate under a changing monetary regime.
[i] Some of you will note that there are in fact three mandates here. A 2007 speech by Governor Frederic Mishkin explained it this way: “Because long-term interest rates can remain low only in a stable macroeconomic environment, these goals are often referred to as the dual mandate; that is, the Federal Reserve seeks to promote the two coequal objectives of maximum employment and price stability.”
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