Will August Employment Report Bring September Taper Announcement?

The August employment report will be released at 8:30 am ET and while a tapering announcement may hang in the balance with this report, it’s more clear after Jackson Hole that the health of the labor market will be key in determining when rate hikes will commence following tapering. The median expectation is that 725 thousand jobs were created versus 943 thousand in July with the unemployment rate dipping to 5.2% versus 5.4% the prior month.

Once again, however, the dispersion of estimates for job growth are quite wide with a low of 400 thousand and a high of 1.0 million which adds an element of uncertainty. The miss by ADP earlier this week at 374 thousand private sector jobs versus 625 thousand expected adds another bit of uncertainty. In addition, the August ISM Manufacturing Index’s employment component dipped to 49.0, indicating a slight contraction in manufacturing employment for August.  While a disappointing report most likely delays a tapering announcement until November or December, will a surprising robust beat bring an announcement forward to the September 22 FOMC meeting? That’s the key question the market will be trying to answer once the report is released.

In our podcast this week we speak with Lee Wetherington, Senior Director of Strategy at Jack Henry. We talk about the concept of “Open Banking”, what it means, and why it matters for community banks. It’s an interesting discussion that provides another window into what banking may look like in the near future. The iTunes link can be found here and the Spotify here.

 

 

 

How Do We Determine “Maximum Employment”?

One of the clear messages from Jackson Hole was that while tapering of asset purchases will begin fairly soon, the bar to begin rate hikes will be considerably higher, meaning that once tapering is completed don’t necessarily expect rate hikes to quickly follow. The Fed, and particularly Fed Chair Powell, have been pretty consistent in their messaging that returning to maximum employment is a key goal before starting rate hikes.

How best to measure maximum employment is something the market is wrestling with as the Fed remains somewhat vague on that topic. Is it simply returning to a 3.5% unemployment rate that prevailed pre-pandemic? Could be, but that could also be a bit misleading as the labor force (those working and those unemployed but looking), which is the denominator,  has changed significantly due to the pandemic. Namely,  several million have left the labor force over the past year or more for early retirement, or to care for elderly and/or children, and thus are not counted as unemployed or in the labor force today.  The number of employed remains about 8 million below pre-pandemic level and getting most of those jobs back is probably one criteria in defining maximum employment.

 

Source: Bloomberg

The Employment to Population Rate (total employed/working age population) is one measure that avoids the peculiarities of the labor force calculation and will be very useful in determining when we are close to returning to a pre-pandemic level of employment.  As the chart shows the current rate is 58.4% which is obviously short of the 61.1% pre-pandemic high but certainly much improved from the 51.3% pandemic low. This number is not one that typically gets reported in the highlights, nor are pre-release estimates published, but it will certainly be analyzed by the Fed as we move through the end of 2021 and into 2022.


Underemployment Rate Also Signals Much Ground to Make Up Before Max Employment

Another measure the Fed will be watching in determining a return to maximum employment is the so-called Underemployment Rate, or U-6 in BLS parlance. This captures a wider swath of the labor force by including not only the unemployed but also the marginally attached (not working and not looking currently but still wanting a job), and those wanting full-time work but working only part-time due to business reasons. By including the marginally attached it does recognize those that fell out of the strict labor force definition but would likely return to work when conditions allow.

 

Source: Bloomberg

As the graph illustrates this rate bottomed in December 2019 at 6.8% peaked at 22.9% in April 2020 and currently sits at 9.2%. Bloomberg does not provide forecasts for this metric so it’s a case of wait and see for August. Getting that rate back in the neighborhood of 6.8% is something the Fed will want, but while dramatic improvements were made early in the recovery it’s likely the final 2.5% needed to return to near pre-pandemic levels will become more grudging.

This year started with the rate at 11.7%,  so it’s dropped 2.5% in seven months. Is another 2.5% likely for the second half of 2021? Probably not, as the last six months in 2020 saw a drop of 6.3% so the law of diminishing returns is evident.   Certainly too, with the recent rise in delta variant cases the second half of 2021 could see slower employment growth versus the expectation just a month or so ago. It continues to look like returning the labor market to pre-pandemic levels will take well into 2022, meaning rate hikes could be a late 2022 or 2023 event.


Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 0.09 0.34 0.61 0.93 1.72 2.18
0.50 0.08 0.31 0.55 0.82 1.58 2.07
1.00 0.07 0.28 0.52 0.78 1.49 1.95
2.00 0.27 0.46 0.70 1.38 NA
3.00 0.65 1.31 NA
4.00 1.26 NA
5.00 1.23 NA
10.00 NA

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Published: 09/02/21 Author: Thomas R. Fitzgerald