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Bank on it: The Fed is a friend

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Over the first three quarters of this year, U.S. gross domestic product (GDP) has grown at an average annual rate of 1.6 percent. That is half the growth rate over the same period of last year.

The tightening fiscal policy had something to do with that, but such a huge slowdown cannot be entirely attributed to the 2.2 percent decline in government spending over the first nine months of this year. In fact, accounting for less than 6 percent of GDP, falling public sector expenditures took GDP growth down by only 0.1 percentage points over that period.

(Read more: Does a Federal Reserve taper matter for stocks?)

The slumping investment outlays and a weaker private consumption – the two GDP components accounting for 86 percent of the economy – are much more important causes of this worrying loss of America's growth momentum.

Ominously, private sector investments – mirroring the firms' optimism about expected sales – slowed sharply so far this year to a growth rate of 4.3 percent from a 12 percent annual increase in the first nine months of last year.

Take the Fed's employment objective seriously

Whether, and to what extent, the Fed alone can fix this is an issue whose importance transcends the bubble talk based on extrapolations of historical data.

The Fed's attention is riveted on what the economy is doing, and where it should be to take up the current slack in labor and product markets.

And here is a largely neglected but crucially important statistic to give you the measure of the Fed's task: the U.S. economy is now performing at about half a percentage point below its shrunken growth potential of 2.1 percent – representing the sum of the average annual labor force growth of 0.25 percent and the average annual growth of nonfarm business labor productivity of 1.8 percent.

These labor force and productivity numbers cover the period between the beginning of 2008 and the third quarter of this year for productivity, and the first eleven months of this year for labor force. The reason for this observation period is simple: the year 2008 marks the break from trend growth of 1.3 percent for labor force and about 2.5 percent for nonfarm business labor productivity.

(Read more: Fed's Evans: Open-minded to Dec taper, but prefers waiting)

With this in mind, it should be easy to understand why the Fed continues to cling to virtually zero percent interest rates and large monthly asset purchases. In addition to providing a broad stimulative impact of lower credit costs, the Fed is also trying to prop up household consumption via (a) stronger residential investments (by keeping mortgage rates down) and (b) the wealth effect of liquidity supported equity values.

But the slowly recovering labor markets are the Fed's main stumbling block. Despite notable success in employment growth over the last few years, only 63 percent of the U.S. labor force was either working or looking for a job last month. That number is down from 66 percent in 2007 before the financial crisis set in, and is roughly comparable to the number observed in the middle of the lost decade of the 1970s, when the industrialized world was rocked by the first oil shock.

Weak labor markets will remain a serious problem for quite some time. Numbers released last Friday show that America's actual unemployment rate is nearly double the headline rate of 7 percent. That is what you get when you include people working part-time (7.7 million) because they cannot find a full-time job, and people (2.1 million) who dropped out of the labor force because they were unable to find work.

With the headline unemployment number of 10.9 million, that puts the actual number of people out of work at a staggering 20.9 million, or 13.2 percent of the civilian labor force.

What's equally disheartening is that the number of people looking for a job for more than two years (the long-term unemployed) was unchanged at 4.1 million last month, meaning that nearly 40 percent of people officially recorded as unemployed were becoming virtually unemployable. They are now part of the structural features of the U.S. labor market, where the hard-core unemployment rate (i.e., the structural unemployment rate) is currently estimated at more than 6 percent.

In other words, it will be impossible to get the headline unemployment rate below 6 percent as long as the potential growth rate of the U.S. economy remains what it is now (around 2 percent). Clearly, it will take quite a while to change that.

(Read more: Yes, more jobs, but wage growth holds up recovery)

The Fed will be a fast friend for some time

This is what the Fed is struggling with. I understand that all these numbers and economic prose are much less engaging than the bubble talk, but these are the numbers and the kind of analysis driving the Fed's key policy decisions.

Indeed, with so much slack in the labor markets, investors should find it plausible that the Fed continues to maintain extraordinary amounts of liquidity in the economy.

It is also clear that, for the same reason, the Fed is not in a hurry to begin rolling back its monetary stimulus.

What does all this mean for investment strategy?

I maintain my long-held view that U.S. bond markets will continue to correct, despite occasional rallies as a result of lower-than-expected numbers on economic activity and/or the Fed's large market interventions.

(Read more: Jobs report and the taper)

U.S. equities will continue to benefit from exceptionally liquid markets. They will also be driven by strong earnings growth. After tax profits in the third quarter of this year were nearly 9 percent above their year-earlier levels. And during the first nine months of this year, net profits were a whopping 12.5 percent higher than the year before.

That shows that the Dow's 23 percent gain over the last 12 months had some strong real underpinnings.

The profit outlook remains good. I expect a recovery of productivity growth after a dismal third quarter performance. These efficiency gains and subdued wage costs should keep profit margins widening in a growing economy.

The key message is this: the Fed will maintain easy credit conditions until the economy stabilizes in a growth range of 2.0-2.5 percent. That is the pace of economic activity that will support improving employment conditions in the context of the medium-term inflation objective of around 2 percent.

Follow the author on Twitter @msiglobal9

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.

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