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To decide when the Fed might begin to taper its asset purchases, closely monitor the Fed’s favorite labor market indicators and consider two questions in particular.
What is the purpose of the Federal Reserve’s asset purchases?
“The purpose of the asset purchases is to increase the economy’s near-term momentum, with the goal of improving the outlook for the labor market and helping to promote a self-sustaining recovery with price stability.” Fed Chairman Ben Bernanke, 20 March 2013“The purpose of the new asset purchase program is to foster a stronger economic recovery, or, put differently, to help the economy attain ‘escape velocity’.” Fed Vice Chair Janet Yellen, 4 March 2013
Bernanke and Yellen speak to an economy that can make it on its own, without the assistance from the Federal Reserve, which it and markets continue to depend upon. The failure to achieve “escape velocity” is why the Fed is using its printing press to purchase $85 billion of securities monthly. These purchases will continue, the Fed says “until the outlook for the labor market has improved substantially.” What, then, constitutes a “substantial” improvement in the labor market outlook?
“It is a broad-based improvement in a range of indicators, as well as improvement in output and labor demand.” Bernanke, 20 March 2013
Bernanke, Yellen, and their colleagues list a plethora of labor market indicators, including these ten:
That’s a lot of indicators!Both Bernanke and Yellen emphasize that if any improvement in these indicators is to be sustained, economic growth must quicken. Job growth can’t be strong if economic growth is weak.Yellen hones in on what might be the best indicator of them all: the unemployment rate. Citing Fed research, Yellen notes that,
“Since 1978, periods during which the unemployment rate declined ½ percentage point or more over two quarters were followed by further declines over the subsequent two quarters about 75% of the time.”
“In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.”
“The Committee could vary the pace of purchases as progress is made toward its economic objectives.”
“Our projections for unemployment in the fourth quarter are noticeably lower than they were in September when we first announced our asset purchase program.” (Emphasis added).
“We (do) need to see a sustained improvement. One month, two months doesn’t cut it.”
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2013, PIMCO.
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