Will jobs miss push Fed back to easing mentality?

Despite Federal Reserve Chair Janet Yellen's recent nod to a slowing global economy, the Fed still remains obsessed with the relatively low unemployment rate. This is because of the wrong-minded belief that too many workers will suddenly hyper-inflate our deflating worldwide economy.

Janet Yellen
Jonathan Ernst | Reuters
Janet Yellen

While Yellen and company busily tinker with their Phillips Curve models (plotting unemployment vs. inflation) in a fatuous attempt to determine how many Americans they should allow to find work, they are missing the crumbling economic fundamentals all around them. The flattening yield curve, plummeting commodity prices, and weakening U.S. and international economic data; all illustrate that the asset bubbles created by central banks have started to pop.

The September jobs report showed a net increase of just 142,000 jobs and the unemployment rate holding at 5.1 percent. This came on the heels of a Challenger report that showed layoffs jumped in September, bringing the year-to-date total to more than 493,000 – already higher than all of last year. That puts the 2015 total layoffs on track to be the highest since 2009.

The tenuous state of our economy has led to an unskilled and unproductive labor force. According to the Bureau of Labor Statistics, an employed person constitutes anyone who worked for pay during the survey week. Therefore, if you provided one Uber ride around the block the BLS considers you employed with the same economic relevance as a full-time brain surgeon. In fact, our part-time low-paying job market is the reason productivity growth has averaged a meager 0.45 percent annually during the past four years.

Meanwhile, the Federal Reserve continues threatening to commence a rate-hiking cycle in the misguided fear of inflation emanating from a meaningless unemployment rate. What Keynesian central bankers fail to understand is that inflation only becomes manifest when the market loses faith in a fiat currency's purchasing power, not from more people becoming productive. Nevertheless, the Fed's models stipulate that a low unemployment rate breeds intractable inflation and the liftoff from the Fed's zero interest-rate policy is set for the end of 2015. That is, unless the unemployment rate turns around and starts heading north.

If the Fed starts raising rates, it will be into a yield curve that is already flat in historic terms and becoming narrower, and credit spreads that are already blowing out. Ms. Yellen will be hiking rates into falling long-term Treasury yields, falling core personal-consumption expenditure inflation data, slowing global gross domestic product growth, and tumbling equity and junk-bond prices. The only good news here is the Fed is moving toward a free-market interbank lending rate; and in the long term, this is great for markets and the economy. But in the short term, it will resume the cathartic deflation of asset prices and debt that was short circuited back in 2008.

On top of the slowing global growth yet hawkish-sounding Fed, we find stock-market valuations that are still the second highest in its history. For these reasons, I believe the S&P 500 is going to trade down to the low 1600 area in the next few months before possibly stabilizing. But exactly how low we end up going at least partially depends on how long the Fed blusters about normalizing interest rates. However, with the gravitational forces of deflation getting stronger, Fed policy makers will not be able to get far off the zero-bound range.

Hence, the next big prediction of mine is that the Fed will soon change to an easing monetary policy stance and cause weak-dollar investments to rebound, as the U.S. dollar falls back toward 80 on the U.S. dollar index (DXY).

Pento Portfolio Strategies has held 40 percent to 50 percent cash since the end of 2014 in anticipation of this current bear market and recommends holding only those investments that will profit from a turn in Fed policy away from a hawkish position. While more ZIRP and quantitative easing may not rescue the overall market or economy, it should at least supply a bid for the beleaguered precious metals sector.

Michael Pento produces the weekly podcast "The Mid-week Reality Check," is the president and founder of Pento Portfolio Strategies and author of the book "The Coming Bond Market Collapse."