The Fed is between a recovery and a hard place.
Though the economy’s expansion still doesn’t seem well grounded, the 163,000-gain in March non-farm payroll has triggered more than the usual speculation that the Fed may finally be ready to change a key part of its policy statement at the conclusion of the two-day FOMC meeting Wednesday.
Since the worst of the job market losses in March 2009, the Fed has used the key phrase—"exceptionally low rates for an extended period”— to telegraph to the markets that monetary policy would be as accommodative as possible to foster economic growth.
But with each passing month since the economy started growing again around mid 2009, the guessing game has intensified.
“It’s the most logical,” says Chris Rupkey of Bank of Tokyo-Mitsubishi “It is based on the economic outlook and that’s improving.”
Rupkey is among those economists who believe the economy is stronger than it appears and that a burst of sizable job creation is in the wings.
So does Robert Brusca of FAO Economics, who calls the Fed’s phrase, “shop worn and no longer valid,” given the economic environment? “Rates can move up and still be considered low. The exceptionally low seems to point to zero or near it. That's what they need to get rid of.”
Though data on the consumer and housing fronts has been mixed and at times disappointing in the past two months, the manufacturing sector has shown continued, consistent improvement and the services one finally seems pivoted toward growth.
The missing link—job growth—now appears to be in place. Based on the previous four recession-recovery periods, once payrolls turn positive they stay that way and the gains become consistently larger.
“Once you reach the bottom in jobs you tend to get a rise that is symmetrical with the fall,“ says Brusca, who expects the economy to regain all of the 8-million jobs erased by the downturn.
“One of the next two payroll reports will be big,” adds Rupkey.
Skeptics, however, point to the so-called jobless recoveries following the past two recessions and that payrolls are a mere 52,000 higher than they were in November 2009, as well as persistently high weekly jobless claims. That rules out any change at the April meeting.
“They [FOMC members] would want to see a million jobs over three months, “ says Ram Bhagavatula of the Combinatorics Capital. “That seems to be the trigger [in the past.] The cumulative evidence doesn’t evidence doesn’t push them yet.”
If so, it would also probably rule out any change in language at the Fed’s next meeting, June 22-23, unless both the April and May nonfarm payroll reports had shown out-sized gains. With no meeting in July, August would be the next chance.
“We're still in this marshy, soft recovery; its very delicate,” adds Brian Bethune of IHS Global Insights. “There is absolutely no momentum in terms of the employment markets. Everyone keeps overestimating when that's going to happen.”
Bethune points out that if census and temporary jobs are removed from the March payroll data, the overall gain is marginal.
Though the majority of the FOMC seems to be in no hurry to change the language, a small but vocal group is. The minutes of the last meeting made that clear. The FOMC, however, also said any change in language would be “data driven”—a key qualification it also happened to use during the latter stages of its easing in 2008—and that events not timing would guide policy.
They implied that the risk of premature tightening is much higher than the risk of a delayed one,” says Bethune.
Proponents of a no-change approach say the Fed’s decision to highlight the minority view that the “exceptionally low rates for an extended period” phrase needed to be changed ort dropped was a tactical move.
“What they tried to so in the minutes is shut up the growing counterview that the periods of usefulness is pretty much done,” says Bhagavatula.
For all the debate in and out of the Fed, analysts agree that it has achieved a delicate balance in recent months and that any change in the language would be both significant. It could even spook the markets and be viewed as a tightening in policy.
The FOMC completed its massive purchase program of MBS and GSE debt at the end of March and mortgage rates—as well as other long-term rates--barely budged. Thought it is inevitable that the Fed will sell that debt, analysts say it will be prepare the markets for the disposal program, which many don’t see beginning until 2011.
“Any tweak to that language is going to send rates higher, by at least 25 basis points,” says Bethune.
The decision to raise the discount rate, returning the premium to the traditional higher than the federal funds rate, appears to have had the intended effect of slowed borrowing.
On the inflation front, the non-core rate is at 1.1 percent, barely above the low end of the Fed’s 1-2 percent range, which has also helped keep inflationary expectations in check.
“Everything is going the Fed's way at the moment, “ says money manager Jim Awad of Zephyr Management. “Long rates are low in spite of an awful budget picture. The dollar has strengthened. There’s a gradually improving economy. The market is telling them there's no pressure to change."