09/17/2020

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The Fed is Still a Far Way From Tightening



We had a good jobs report on Friday, adding 195K workers in June with unemployment holding at 7.6%.  And we had some good revisions to previous numbers as well, pushing the three month average to nearly 200K a month.  The bond market sold hard on this news, with a quantitative easing (QE) exit all but certain to start in September and tightening being priced in for late 2014.  While I’m not one to catch a falling knife – e.g., stand in the way of the one-way bond market sell-off, I think tightening doesn’t happen until 2017.


Never advised, especially in a one-way bond market

The Fed has set an explicit target of 6.5% unemployment to start the clock on tightening.  Note that the Fed believes the non-inflating rate of unemployment to be about 5.6%, so the 6.5% level is a necessary but not sufficient condition to tighten.  With job growth running at 200K/month – about 50K/month higher than pre-crisis levels – how far are we from hitting the Fed threshold?

The following chart shows the size of the potential workforce in the US, along with labor participation rates.


Source: BBG, BLS

Participation rates dropped during the crisis, and now stand at 63.5%, below the 66% pre-crisis trend.  Many economists have suggested this drop is structural – baby boomers retiring.  That would explain a drop in participation, but seems incredibly coincidental to the crisis and is at odds with both the continued steady growth in the potential labor force and the 7.2 million people the Bureau of Labor Statistics reports who are not in the labor force but who want a job now (highest since 1994).


You have lots of company

The following table shows when the 6.5% unemployment threshold is hit, assuming a growth in workforce of 2 million workers year over year (the current level).

Source: BLS, Cabezon

I believe that participation rates will retrace at least half of what they lost in the crisis.  Retiring baby boomers will be at least partially offset by workers re-entering the workforce.  Assuming we can continue to run at a 200K/month jobs rate, that puts 6.5% unemployment happening in May 2017.

I don’t believe the Fed is ending QE because they feel good about the economy.  Rather, I think the Fed doesn’t know whether QE does anything other than inflate asset prices.  QE has to end at some point (doesn’t it?) and Bernanke – the exiting Chairman – took the bullet so Yellen doesn’t have to.  I still have doubts that the Fed can exit at all, but it isn’t time to be long duration.  However, it is time to go long some 2014 Eurodollars.

March 2014 contracts are pricing 3-month Libor at 47 bps. (99.53 price)  Spot is at 27 bps and grinding lower.  20 ticks is $500 on a $250 margin contract.  That’s good math, even for an economist.


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