Sufficient job growth is the missing link in what has been a sluggish economic recovery, but so-so employment gains may be the only thing keeping the Fed from tightening its loose policy stance. Without an aggressive monetary policy in place, the stock market may not be able to continue its recent hot streak.
Indeed, stocks started 2013 with a bang, with the Dow Jones Industrial Average soaring 3.8% in the first trading week of the year. Even better was performance from tech stocks and small caps, with the Nasdaq Composite up 4.8% and the Russell 2000 Index up 5.7%. Two records were made with last week’s performance. Not only was this the best one-week return for the Dow since Dec. 2, 2011, but also the S&P 500 hit a five-year high.
S&P 500 data reflects total return, including reinvestment of dividends.
The End of QE Infinity?
Some members of the media and pundits have attributed last week’s ebullience to the resolution of the fiscal cliff. However, while the deal gave stocks a big boost on Wednesday, the rally lost momentum on Thursday with the release of the minutes from the December Federal Open Market Committee meeting. The report suggested “QE infinity” may be winding down fairly soon, shocking many market observers who had expected the unique monetary tool would have longer legs. The minutes showed that in evaluating macroeconomic conditions, specifically the job market, a few committee members argued that ongoing asset purchases would likely only be justified until about the end of 2013.
But that’s not all; it turns out that “several others thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet.” And one member argued that bond buying should end now, saying additional purchases are “unwarranted.”
Still, the minutes provided some reassurances. First, interest rates would not be treated in a similar fashion, as the FOMC members expect the “highly accommodative stance” on monetary policy to remain in place for “a considerable time after the asset purchase program ends and the economic recovery strengthens.” Second, guidance continues to point toward keeping the federal funds rate very low. That guidance is predicated on the following conditions: the unemployment rate remains above 6.5%, inflation projections for the next one to two years stay at or less than a half-percentage point above the committee’s longer-run goal; and longer-term inflation expectations continue to be “well anchored.”
Last, the FOMC said it expects that its change to economic thresholds as the barometer for determining when to raise rates will result in an outcome that is “consistent with its earlier, date-based guidance.” It’s important to note that the FOMC has already stressed that it will look at other means of monetary tightening before raising rates if one of the thresholds is breached.
It’s no surprise that on Friday the stock market welcomed the most recent jobs report from the Department of Labor. The report tells us that the jobs recovery continues but at a snail’s pace, perhaps extending the life of the Fed’s highly accommodative stance. Non-farm payrolls showed modest gains, with 155,000 jobs created, in line with the average of 153,000 jobs per month over the past two years. The unemployment rate for December rose to 7.8% and the unemployment rate for November was adjusted upward from 7.7% to 7.8%. The recent rise in the jobless rate is being driven by growth in the labor force exceeding the household measure of employment growth, while the participation rate was unchanged. In 2012, we’ve seen the unemployment rate fall to 7.8% from 8.3%, but we’ve seen little progress since September.
Meanwhile, we also saw the continuation of a trend I identified in a previous Upshot: a large portion of the jobless fall into the “long-term unemployed” category: the number of people unemployed 27 weeks or more was essentially unchanged in December at 4.8 million and accounted for 39.1% of the unemployed, down from 40% in November. A high proportion of persistently unemployed people suggests that the job situation will likely not improve dramatically any time soon.
In light of the FOMC minutes, it should not come as a surprise that investors responded positively to the mediocre jobs report. Now that the Fed is showing a laser-like focus on jobs, a middling report should keep monetary tightening at bay, and could breathe some life into the Fed’s bond-buying program. This is especially true since the economic backdrop appears stable. For example, the December ISM manufacturing report shows the factory sector is back in expansion mode, although just barely, and the December ISM Non-Manufacturing Survey underscores the good health of the service sector. In addition, the American Bankers Association released data last week showing that credit-card delinquencies—payments that are 30 days or more overdue—fell to an 18-year low in the third quarter of 2012, the latest data available.
The economy is recovering but at a painstakingly slow pace. And that, while seemingly counterintuitive, may be good news to equity investors. It appears the stock market will respond best to a “Goldilocks” economy, one that’s not so cold as to signal real trouble but not so hot that it will force the Fed to end its extremely accommodative stance.
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