Published October 22, 2013
The shutdown-delayed September jobs report likely buys QE-drunk Wall Street even more time before the Federal Reserve begins to take the easy-money punchbowl away.
That’s because the latest nonfarm payrolls report reinforces concerns labor growth has slowed down. At the same time, upcoming jobs reports are likely to be muddied by the shutdown and future fiscal fights are possible early in 2014.
The conventional wisdom on Wall Street, which has been proved wrong before, now calls for the Fed to hold off on dialing back quantitative easing until late March -- a full six months after the central bank had been widely expected to begin “tapering.”
“The doves are not satisfied with what they’re seeing in the labor markets. And we know the data will be pretty messy for the next month or two because of the government shutdown,” said Ed Yardeni, president of investment advisory Yardeni Research.
A delayed taper is good news for risky assets like stocks, at least as long as euphoria for equities doesn’t get too out of whack with fundamentals.
The Dow Industrials briefly rallied more than 100 points Tuesday morning as traders bet the QE spigot will remain firmly open.
Lackluster Jobs Report
The Labor Department said nonfarm payrolls increased by 148,000 jobs in September, trailing consensus calls for a gain of 180,000 and 2013’s previous average gain of 181,000.
“Ever since 2008 companies are incorporating into the business plan the possibility it could happen again. They are very conservative with their hiring and only hire when they absolutely need to,” said Yardeni.
Looking beyond the headline numbers, the jobs report showed private service-producing employment increased by only 100,000 jobs in September, the slowest pace since June 2012, according to Nomura. Average hourly earnings inched up by 0.1%, compared with consensus forecasts for a rise of 0.2%.
“We see this job report as leaving policymakers unsatisfied with the pace of improvement and reduces the likelihood the Fed tapers asset purchases in the near future,” Michael Gapen, director of U.S. economic research at Barclays (BCS), wrote in a note Tuesday.
‘Higher Bar’ for Tapering
Barclays now sees the Fed dialing back its $85 billion-monthly bond purchases in March, rather than it's previous expectation the Fed will begin to taper in December. The bank believes QE will end in September 2014, not in June as it previously forecast.
Economists at Nomura said they believe the combination of the “underwhelming” September report and possible sampling errors in the October report creates “additional headwinds” for the Fed to dial back QE.
The October sampling errors are expected to stem from the government shutdown, which furloughed many Labor Department employees who compile the data. November’s jobs report is also likely to be muddied by a reversal in the October report.
“We believe this will lead to a higher bar for the start of tapering of QE3 at the end of the year and continue to expect tapering to begin in Q1 2014,” Nomura said in a note.
Jon Hatzius, chief economist at Goldman Sachs (GS), told clients in a note March is the “most likely date” to taper QE, assuming “the next set of fiscal deadlines proves less disruptive than the most recent set.”
Under the compromise reached last week, the debt ceiling has been suspended until February 7, although the Treasury Department likely has wiggle room to use extraordinary measures to push that date out further.
Could the Fed Surprise Again?
Fed watchers believe the central bank is unlikely to be swayed by the shrinking unemployment rate, which dipped to 7.2% in September -- the lowest level since November 2008.
While Bernanke previously set the 7% unemployment level as a goal, he has since backed away from that measure due to concerns about volatility as Americans drop out of the workforce.
“We believe many on the committee are willing to view the decline in the unemployment rate as overstating the pace of improvement in labor markets,” Gapen said.
Of course, a decision by the Fed to scale back QE in late March isn’t a done deal.
After all, the consensus thinking on Wall Street predicted the central bank would begin tapering in September, only to be proven wildly wrong. Conventional wisdom also held that the government would avoid a shutdown, but the fiscal impasse ended up closing the government for more than two weeks.
“They surprised us by not tapering so I guess they could surprise us by out of the blue deciding to taper,” said Yardeni.
But Kevin Cummins, U.S. economist at UBS (UBS), said he thinks the September report was weak enough to prevent such an outcome.
“The latest data raise the possibility you are losing steam and momentum in the labor market. I really wouldn’t expect them to surprise people again because that would tighten financial conditions again,” said Cummins.
On the other hand, the economy could prove too weak to handle the Fed taking its foot off the QE accelerator even in late March.
Chris Williamson, chief economist at Markit, said he believes the Fed will start dialing back QE in January or March. However, he said, “this is by no means assured, especially if the shutdown and budget crisis has hit business confidence, and therefore investment and hiring plans.”
The delayed tapering is likely to be a tailwind for risky assets like stocks, which have benefited from the Fed’s expanded balance sheet.
Thanks in part to the Fed stimulus, the S&P 500 has already rallied more than 22% this year and notched 29 different record closes.
But some worry the market could get too far ahead of the mediocre economy, creating a dangerous melt-up scenario that could lead to a steep slump.
Yardeni, a longtime market bull, told clients this week, “At some point, we may have to worry that the melt-up that seems to be taking off will be followed by a meltdown.”