Friday’s report on US employment looked lackluster to most people, but it should be welcome news for bond investors, who watched in horror on Thursday as yields leapt to eight-month highs. The selloff occurred after news from the Federal Reserve signaled that it might end its ultra-loose monetary policy sooner than expected. The job data were particularly important given that the Federal Open Market Committee will meet again late this month, before the release of January’s employment numbers.
While the lack of upbeat news should give the Fed little basis for putting its foot on the brake, Thursday’s dramatic market reaction indicates some dissonance between what the Fed was saying and what markets were hearing. Tuesday’s release of the Federal Open Market Committee (FOMC) December minutes revealed that the committee has been considering winding down the central bank’s third round of asset purchases—known as “quantitative easing,” or QE3—as early as the middle of this year. At present, the Fed purchases $85 billion in Treasurys and mortgage-backed securities (MBS) each month.
Even a pull-back from the policy at the end of 2013, as more members seemed to favor, would be much sooner than expected, given the Fed’s December announcement that it would sustain loose policy until tangible recovery was underway, a move that many hailed as “aggressively dovish.” The specifics of that plan saw the Fed tie QE to dual inflation and unemployment rates of 2.5% and 6.5%, respectively—economic thresholds that the central bank would target as it weighed whether to tighten.
Media and markets alike interpreted this as an invitation for businesses and individuals—and investors—to spend freely, without fear of an economic contraction around the corner. As bond investors rightly worry, pulling back on asset purchases would be lousy for US economic growth, particularly considering the likelihood of increased austerity that will result from the resumed negotiations on spending cuts as part of the deal to resolve the “fiscal cliff.”
While the lack of momentum on job growth should elicit modest confidence that the Fed won’t halt its asset-buying at least until late 2013, there are other reasons for optimism. The minutes’ vague wording makes it impossible to tell exact breakdowns, but at the very least, the 12-member group appears to be close-to evenly split on QE3 timing, notes Robin Harding (paywall). Meanwhile UBS highlights that an impending guard-change of the voting Fed members will skew “dovish,” meaning more amenable to keeping monetary expansion in place.
However, there are other reasons for a dimming of confidence in divining the Fed’s plans. For one thing, the economic threshold strategy was focused on raising interest rates alone. The Fed’s monthly purchase of $85 billion in mortgage-backed securities and Treasuries, which is keeping the economy flush with liquidity, is guided only by “quality” measures and not the quantifiable thresholds that rates were set at. That makes the Fed’s plans for asset-buying much harder to interpret. It also makes the commentary of the non-voting members worth taking into account. This alters the consensus somewhat, points out Greg Ip, noting that the “median member wants to stop between the middle and end of 2013.”
Will that be long enough to warrant taking the US economy off its $85 billion-a-month drip—or for the economy to grow if the Fed does stop buying? That will depend on a host of factors, naturally. But the details of Friday’s job report data may offer a clue to at least one of them: the housing recovery. In addition to keeping money loose, the Fed’s purchase of mortgage-backed securities is aimed at coaxing a housing recovery—particularly important, considering that residential investment is typically a big driver of GDP growth. Today’s data show that construction suggests a growing bounce-back, as the economy added 30,000 construction jobs—a 4,000 increase from last year and two times as many as in October. (November’s data was blighted by the effects of Hurricane Sandy.) Commercial slightly beat out residential in driving this trend. But it’s still good news.