From Westpac’s Elliot Clark today:
Last night saw newly-installed Fed Chair Janet Yellen make her first trip to Capitol Hill for the semi-annual testimony to Congress. In the lead-up to the event, there was some debate as to whether the recent softer data – particularly for jobs – would see a change of tack, with a more dovish perspective given on the outlook. As we had expected, this was not the case, with the optimistic outlook recently given by the FOMC and Fed speakers reiterated. That being said, the prepared remarks and Q&A also made clear the ways in which the FOMC’s expectations could be disappointed, potentially bringing about a pause in the tapering process.
On growth, it is fair to say that the FOMC continues to take an optimistic view. Chair Yellen noted that growth had picked up from 1.75% in the first half of 2013 to 3.5% in the second, driven by stronger business and household spending. That the contribution to growth of fixed asset investment (excludes inventories) was actually weaker in 2013 than 2012 was not discussed, nor was the importance of consumer credit growth to the pick-up in consumption owing to a lack of household income growth. Also missing from the discussion was the significance of robust inventory accrual to business investment and indeed overall growth: inventories contributed 0.8ppts to 2013’s 2.7%yr headline result.
On the labour market, the focus was very much on the cumulative improvement in the jobs market since QE3 was implemented versus current momentum, which has waned of late. Chair Yellen highlighted that 3.25mn jobs had been created since August 2012, the month before QE3 was announced. However, what was not discussed was that, over the same time period, the civilian population increased by 3.48mn, the implication being that job growth has failed to keep pace with the population. (As an aside, it is worth mentioning that these two figures come from different surveys; the corresponding household employment gain is 3.02mn.)
Had the participation rate not fallen since August 2012 – owing to the retirement and disenfranchisement of workers aged 45 and older – we would have actually seen an increase in the unemployment rate. For the 45 to 54 age group, the participation rate has declined by 1.1ppts since August 2009; for the 55+ group, the participation rate has fallen by 0.6ppts. This change in participation is different to the ageing effect typically highlighted by market participants which is a function of the older age groups’ rising share of the population and their comparatively lower level of participation.
On inflation, there was little in the way of concern from the Fed Chair. Yes inflation is well below the FOMC’s 2% policy objective, but “some of the recent softness reflects factors that seem likely to prove transitory, including falling prices for crude oil and declines in non-oil import prices”.
From the above discussion, it seems very unlikely that the recent softening in the pace of job creation, nor a continuation of soft inflation outcomes, would give the FOMC cause to pause the taper process. While not discussed in detail, the impact tapering is having on emerging markets is also unlikely to dissuade the Fed from tapering. What we need to see then is: an abrupt slowing in activity and/or job growth; a further slowing in inflation, sparking deflation concerns; or a global market rout large enough to materially impact US markets.
Of these threats, much weaker than expected activity growth is the most probable. Indeed, as outlined last week, this is our base case. While we have confidence in our sub-trend growth view, it is important to recognise that it will take a number of months to come to pass. And in the meantime, given the FOMC’s focus on the cumulative job gain, the tapering process seems unlikely to be paused at either of the next two meetings (March and April). The June meeting has the additional benefit of a press conference, allowing the FOMC to clarify changes to its guidance.
A quick note on a number of longer-term issues serves as this week’s conclusion. While the current debt ceiling impasse looks to have been resolved with little tension, further material improvement in the fiscal position will prove difficult absent strong job growth, making further spending cuts necessary in ensuing years. Also, the ageing of the population, the ongoing deterioration in working conditions, and the reduced participation of younger workers in the labour force is setting up a troubling dynamic for future discretionary spending growth.
The ballooning of student loan debt over recent years is the core concern. Without well-paid, full-time jobs with good benefits, these workers are going to be ill-equipped to undertake the household formation activities on which the past two decades of US growth have been founded. It also bodes ill for the ability of all levels of Government to provide for those who are retiring or have suffered skill-degrading, long-term unemployment. All economic agents would be well served to remember that it is not only the month-to-month change in the Fed’s purchases that matter to the US and global economies, but also the structural difficulties that remain ever present.
