Dealers and Fed Need to Come to Terms on Structural Unemployment

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March 26th, 2012

Speaking Monday on recent developments in the U.S. labor market, Fed chair Bernanke asserted, “A significant portion of the improvement in the labor market has reflected a decline in layoffs rather than an increase in hiring.” He closed his speech by saying, “If structural factors are the predominant explanation for the increase in long-term unemployment, it will become even more important to take the steps needed to ensure that workers are able to obtain the skills needed to meet the demands of our rapidly changing economy.” The markets took that phrasing as a signal that additional quantitative easing is back in play. But dealers differ on “the steps needed” and whether or not it is the Fed’s intent to take them.

“To achieve a more rapid recovery in the job market, hiring rates will need to return to more normal levels.” — Bernanke


According to the latest (January) data from the Job Openings and Labor Turnover Survey, the number of job openings in the U.S. has increased 45 percent since the end of the recession in June 2009, while over the same 32 months, the number of hires has risen only 13%. Likewise, while the job openings rate has been steadily climbing back toward pre-recession norms, the hires rate has noticeably lagged, having only moved sideways between 3.0% and 3.3% for the past 20 months. Nevertheless, as nonfarm payroll changes closely match net job creation in the JOLTS data, the ongoing improvement in the former strongly indicates that the depressed hiring rate will pick up.

Assessing the potential market impact of the Bernanke address, economists at Jefferies & Co. postulated, “We’ve been saying for weeks that QE3 is still on the table despite some cross-currents emerging in the FOMC-speaker headlines and the stronger appearance of domestic economic data. Bernanke just confirmed that he favors more action to boost growth so this debate is clearly alive and well. The next two FOMC meetings are scheduled for April 24-25 and June 19-20. We expect an announcement of a new purchase program focused on MBS with a long-end Treasury component that will dovetail with the end of Operation Twist.”

The economics team at Bank of America Merrill Lynch believes Bernanke’s hand is hovering over the easing button. “In the Q&A period, Bernanke said it was important for the Fed to remain cautious and to look for ‘pervasive’ improvement in the outlook. He argued, ‘continued accommodative policies’ can help support the recovery. This isn’t a clarion call for more QE, but it strongly indicates that the Fed has not ruled out further easing, nor is likely to exit as early as the market now expects. Under our forecast, growth slows in the second half of 2012, and Bernanke’s fears of a halt to the improvement in the jobs market are realized. In that case, we would expect QE3 to be implemented by late summer or early fall.”

Suggesting the policy bias requires more observations on standard labor market variables, BNP Paribas Market Economics wrote, “The bar for engaging in some form of QE3 would be a failure of the growth data to accelerate noticeably between now and June when Operation Twist comes to an end. Any weakening in hiring or pick up in global financial market turmoil would also add to the case to do more. Since we expect growth to continue to hover around 2% in H1 and for job gains to slow somewhat in Q2, we continue to see the roll out of a new easing program as likely in June. The decision of whether to do more and what form further easing would take is highly data dependent at this point, but the bias is still to do more rather than less.”

If perhaps the Committee remains split on the need for additional easing, UniCredit Research submitted that based on today’s dovish speech, the FOMC is certainly not biased toward hiking. “While we think that the recent improvement in the economic situation – notably the labor market – has clearly lowered the odds for any further policy accommodation in the near term, the Fed has no urgency to withdraw monetary policy stimulus. If anything, Bernanke’s warning that the cyclical labor market problem might convert into a structural one, might be a call for even more easing.”


Not judging Bernanke’s speech as so dovish as to now expect QE3, J.P. Morgan North America Economic Research said nonetheless, “We do think it serves as a reminder that it probably wouldn’t take much of a deterioration in the labor market — i.e., a rise in the unemployment rate — to induce the Fed to initiate another round of asset purchases. We think the more relevant policy message from today’s speech is that it is premature to believe that Fed leadership is even considering tinkering with the late 2014 rate guidance. In the past few years the Fed was sometimes quicker to embrace improving data. This time, however, Bernanke seems to view labor market normalization as a marathon rather than a sprint, and is taking a more patient view in processing signs of an improving job market.”

UBS Global Economics Research interpreted the Fed chair’s speech quite differently from other dealers, asserting, “Mr. Bernanke did not hint at any more aggressive accommodation.” Further, UBS thinks Bernanke’s depiction of employment conditions is flawed. “Our view is that the unemployment rate will fall from the current 8.3% rate to 7.8% in Q4’12 and 7.3% in Q4’13 – below consensus and Fed expectations in both years. We also think structural unemployment is a bigger problem than does Bernanke. The shift in the Beveridge Curve does not, to us, look ‘modest’.”

While conceding that “a substantial portion of the decline in the unemployment rate does reflect genuine improvement in labor market conditions”, Bernanke obliquely encouraged the markets on Monday to look more closely at broader labor market sketches such as the Job Openings and Labor Turnover Survey (JOLTS)*. Although reported with a longer lag than the nonfarm payroll report, JOLTS data give more reliable indications of labor demand and, through the lens of the Beveridge Curve, a limited capacity to identify the extent to which cyclical and structural factors (and in what combination) are keeping long-term unemployment elevated. As the next set of JOLTS data appears two weeks before the start of the April 24-25 FOMC meeting, dealers will be watching gross job flows, particularly the hires rate, with far more interest than usual.

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