Vital Signs: Fed's Rate Policy Depends on Jobs Recovery

Investors will have plenty to think about this week. Federal Reserve policymakers will sit down on Tuesday and Wednesday to discuss the economic outlook and future policy strategy, with the Fed’s statement due at 2:15 p.m. on Wednesday. Then, first thing Friday morning, the Labor Dept. will issue its October employment report. Both are potentially market-moving events.

Keep in mind, though, that future Fed tightening and labor market improvement are pretty much joined at the hip. Joblessness, at 9.8% in September, is far above the 5% or so level the economy can sustain without generating inflation pressures. For the majority of policymakers, that implies enormous slack in the economy, which continues to put downward pressure on both wages and prices, raising the risk of deflation. The Fed is not likely to begin the process of taking back its massive amount of stimulus until the job markets are clearly on the road to recovery, which is unlikely to be evident until well into 2010.

The October job report is unlikely to change perceptions about the weakness in the labor markets, but it may well suggest that the pace of job losses is at least slowing. Economists surveyed by Action Economics expect payrolls to drop by 180,000. That would be the smallest decline in more than a year. They also look for the unemployment rate to edge up another tenth of a point, to 9.9%.

Despite weak labor markets, the debate within the Fed over when to start reining in policy has already begun. Minutes of the Fed’s September meeting show the hawks are skeptical of the doves’ arguments about economic slack. They say popular measures of the amount of under-utilized workers and production facilities can give misleading impressions on the amount of slack, as was the case in the 1970s. Plus, they worry that exceptionally easy policy could eventually fuel expectations of higher inflation, which are very difficult to reverse once they are engrained in business and consumer behavior.

With the economic recovery now taking hold, deflation, while still as issue, is becoming less of a threat. The economy grew 3.5% in the third quarter, with a significant contribution from overall demand beyond car-buying. Plus, the typical inventory-led thrust to economic growth, which is always a big factor early in recoveries, has barely even begun. Economists look for inventory gains and a modicum of demand growth to keep the economy growing in the 3% to 4% range in coming quarters. That’s weak by past recovery standards, but fast enough to generate job growth, which will be essential to sustaining the recovery.

So far, the doves are clearly in control of policy, as the Fed’s Nov.. 4 statement is expected to reflect. However, policymakers may soon feel the need to back away from their long-standing commitment to keep rates at "exceptionally low levels" for "an extended period." The Fed may be close to the time when it feels it may need a little more flexibility in the future. However, any change in this particular wording in the statement would be interpreted as a significant shift in the Fed’s thinking and the first baby step toward policy tightening. Amid still-weak job markets, that’s probably not a signal the Fed is ready to send just yet.

Here’s the weekly calendar, from Action Economics.

  Top Economic Reports Top Reports Date Time For Mean Estimate Last Period ISM Index (Manufacturing) Monday, Nov. 2 10:00 a.m. October 53.0 52.6 Construction Spending Monday, Nov. 2 10:00 a.m. September -0.4% 0.8% Factory Orders Tuesday, Nov. 3 10:00 a.m. September 1.0% -0.8% Domestic Auto Sales (Millions) Tuesday, Nov. 3 afternoon October 3.4 3.3 Domestic Light Truck Sales (Millions) Tuesday, Nov. 3 afternoon October 3.5 3.5 ISM Index (Nonmanufacturing) Wednesday, Nov. 4 10:00 a.m. October 51.8 50.9 Nonfarm Productivity (Preliminary) Thursday, Nov. 5 8:30 a.m. Q3 5.3% 6.6% Unit Labor Costs (Preliminary) Thursday, Nov. 5 8:30 a.m. Q3 -3.8% -5.9% Nonfarm Payrolls (Thousands) Friday, Nov. 6 8:30 a.m. October -180 -263 Manufacturing Payrolls (Thousands) Friday, Nov. 6 8:30 a.m. October -45 -51 Unemployment Rate Friday, Nov. 6 8:30 a.m. October 9.9% 9.8% Average Hourly Earnings Friday, Nov. 6 8:30 a.m. October 0.2% 0.1% Average Weekly Hours Worked Friday, Nov. 6 8:30 a.m. October 33.1 33.0 Wholesale Trade Sales Friday, Nov. 6 10:00 a.m. September 0.5% 1.0% Consumer Credit ($Billions) Friday, Nov. 6 3:00 p.m. September -$6.0 -$12.0   Other Reports and Events Other Reports and Events Date Time For Pending Home Sales Index Monday, Nov. 2 10:00 a.m. September SPEECH: Fed Governor Tarullo Monday, Nov. 2 3:15 p.m. ICSC-UBS Store Sales Tuesday, Nov. 3 7:45 a.m. Oct. 25-31 Johnson Redbook Weekly Store Sales Tuesday, Nov. 3 8:55 a.m. Oct. 25-31 Federal Reserve FOMC Meeting (First Day) Tuesday, Nov. 3   Mortgage Applications Wednesday, Nov. 4 7:00 a.m. Oct. 25-31 ADP Employment Data Wednesday, Nov. 4 8:15 a.m. October Federal Reserve FOMC Meeting (Second Day) Wednesday, Nov. 4 2:15 p.m. Statement Initial Unemployment Claims Thursday, Nov. 5 8:30 a.m. Oct. 25-31 SPEECH: Fed Governor Duke Friday, Nov. 6 3:00 p.m.

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