Gauging Tapering Post November Jobs Report

Markets Flat Amid Full Week of Data

Equity markets narrowly avoided breaking a streak of eight straight weeks of positive performance last week. Robust gains on Friday sparked by a better than expected government jobs report left markets with a 0.01% gain for the week. Bonds slipped 50 bps, the fourth weekly loss in the past two months.

Last week provided a full slate of economic data, spanning multiple sectors of the economy.

On Monday, the Institute for Supply Management (ISM) released their much heralded manufacturing index. The diffusion index rose to 57.3, a surprise increase that pushed the indicator to its highest level in more than two years. Economists had expected a modest slip to 55.5. Readings above the 50-level indicate economic expansion.

The ISM index was propelled by strong gains in its most important components, including new orders, production, and employment. Each of those measures is solidly in expansionary territory, and suggest continued momentum entering the end of the year. Overall, the ISM manufacturing index has marked a surprising turnaround from just six months ago, when it teetered on the 50-level. The last five months have posted above 54.0.

ISM’s other major report, the non-manufacturing index, also made its way to investors last week. This one was slightly less encouraging, however, as it slipped to the downside below expectations. At 53.9, though, the index remains expansionary and has offered a far more consistent source of economic strength for the US economy. The index has been above the 50 level for 47 straight months.

On Thursday, the second reading on third quarter GDP was much stronger than anticipated. The 3.6% seasonally adjusted annualized rate of growth was the strongest since the first quarter of 2012 and marked an increase from the preliminary estimate of 2.8%. Unfortunately, the positive revision was primarily driven by inventory increases, an unsustainable source of growth. This sets the stage for potential mean reversion in the fourth quarter.

On the housing front, investors were treated to two months of new home sales data due to prior disruptions caused by the government shutdown in October.

In September, new home sales slipped 6.6% to a pace of 354,000 homes. This is the third straight month of depressed levels, following an average of 445,000 through the first six months of the year. Softness was broad based, with sales declines observed across all major regions.

October provided a more constructive view of the market, as sales rebounded back to H1 2013 levels. October’s figure of 444,000 sales represented a 25% spike from the prior month. It remains to be seen, however, whether this is a one month anomaly or whether the new home market can turn around a steady slide that has been in effect for several months. A combination of higher mortgage rates and apprehension about Congressional competence appears to be weighing on this segment of the economy.

Gauging Tapering Post November Jobs Report

With another month down in 2013, last week came time to dissect the latest report on employment. If the market reaction was indicative, the highly anticipated November labor report did not disappoint, sending stocks up more than 1% on Friday.

To recap, labor markets added 203,000 jobs in November, and the unemployment rate went from 7.3% to 7.0%. Most major sectors were positive contributors in November, with the strongest job gains coming from education & healthcare, professional & business services, transport & warehouse, manufacturing, retail trade, leisure & hospitality, and construction.

Source: Bureau of Labor Statistics

The stronger than projected report raised chatter that the Federal Reserve would likely implement it’s much discussed taper program in mid-December. The Federal Open Market Committee (FOMC), which sets policy, is scheduled to meet December 17 and 18. While the report does point to improving trends in the labor market, the probability of tapering is somewhat low for the upcoming meeting.

At issue is that while the unemployment rate is relatively in line with Fed forecasts, Calculated Risk Blog highlighted recent comments from Fed Chair Ben Bernanke, where he said the unemployment rate “probably understates the weakness of the labor market.” Additionally, Janet Yellen will assume Bernanke’s role early next year, and there are some who believe Bernanke does not want to commit to tapering in advance of that transition.

Source: Calculated Risk Blog

There are reasons to believe Bernanke’s assessment of labor markets is in fact accurate. For starters, the labor force participation rate remains at multi-decade lows, nearly 11 million people continue to be unemployed, and 4.1 million of those people have been unemployed for 27 weeks or more. A measure combining unemployed workers along with people discouraged from looking for jobs, and those working part-time but desiring full-time employment, stands at 13.2%.

Source: U.S. Economic Snapshot

There is good news embedded within the latest report, though. November was the third strongest month of job gains this year, with the three-month average growth rate now climbing to 193,000. November also witnessed average hourly earnings increase 0.2%, and average weekly hours rise to 34.5.

Overall, this was an encouraging report for labor markets, despite the structural shortcomings that still exist. The improvement experienced in the past two months will increase discussion about tapering in the upcoming FOMC meeting, but there is unlikely to be any shift in policy for the foreseeable future. Labor markets are one piece of the broader puzzle, and improvement is occurring slowly.

The Week Ahead

This week quiets down on the economic front. On Tuesday, The National Federation of Independent Businesses (NFIB) will release its small business optimism survey. Later in the week, retail sales and producer inflation is on tap.

Outside of the US, important data on Chinese industrial production and retail sales is due.

The European Union also releases industrial production data. Japan also reports a second estimate of third quarter GDP.

Central bank activity is limited to primarily emerging markets this week, with rate announcements from New Zealand, Indonesia, Korea, the Philippines, Chile, Peru, and Russia.

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