Popular Economics Weekly

Fed Chairman Bernanke once more ‘clarified’ his remarks, saying there is no way the Fed will even begin to raise their (short term) interest rates when the unemployment rate falls to 6.5 percent.

“There will not be an automatic increase in interest rates when unemployment hits 6.5 percent,” said Bernanke. “And, given the weak labor market and low inflation, “it may well be sometime after we hit 6.5 percent before rates reach any significant level,” the Fed chief added.

So there is also good reason to believe the Fed won’t begin to ‘taper’ purchases of QE3 securities this year, either. Why? The labor market is even weaker, and the real unemployment rate is much higher, than the current 7.6 percent.

Calculated Risk and many others have noted a significant portion of the decline in the unemployment rate from 10.0 percent in October 2009 to 7.6 percent in June 2013 was related to a decline in the employment-to-participation rate from 65.0 percent in Oct 2009 to 63.5 percent in June 2013.  If the participation rate had held steady, the unemployment rate would be 9.7 percent (assuming an increase in the participation rate with the same employment level).

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Graph: Calculated Risk

Some 2 million discouraged workers have been sitting on the sidelines for more than 6 months and the labor participation rate was as high as 67 percent until the Great Recession, which tells us why this recession was so deep. Most of the unemployed are now the 24 to 55 year-olds of prime working age, which is a tremendous loss of the most productive workers.

The June 195,000 non-farm payroll increase was a good number, though not the 300,000 per month that prevails during a healthy economy. The change in total nonfarm payroll employment for April was revised from +149,000 to +199,000, and the change for May was revised from +175,000 to +195,000. With these revisions, employment gains in April and May combined were 70,000 higher than previously reported.

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Graph: Calculated Risk

Another reason QE3 may not end soon is the downgrading of GDP growth estimates. The IMF just downgraded its prediction of U.S. GDP growth to 1.8 percent in 2013. The Fed now has the most optimistic growth projection of 2.3 to 2.6 percent in 2013.

So who do we believe? It looks like the Fed wants have its cake and eat it, too, as they say. It wants to tell the markets that the outright purchase of $85 billion per month in securities has to end eventually, because economic growth will pick up. But when? It is in effect trying to boost what is called the yield curve of longer term interest rates, without any signs that growth is increasing.

So once again the Fed is playing the expectations game. But that can be a two-edged sword, as we’ve said in the past, because right now the markets are betting that higher rates mean slower growth ahead.

Harlan Green © 2013

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