By: Ryan McCarroll
In his remarks following the June FOMC meeting, Chairman Bernanke reminded market participants that “QE Infinity” is, in fact, a finite program. In his statement, he outlined the conditions under which the Fed would begin to curtail its asset purchases. This announcement rattled fixed income markets. In the subsequent five trading days, the yield on the ten year Treasury increased 42 basis points from 2.19% to 2.61%. Based on current market conditions, many economists expect “tapering” could occur as early as the September FOMC meeting. As mentioned in last month’s market commentary, the drawdown of QE will no doubt result in near term volatility; however it can be viewed as a positive sign, as markets can return to more fundamental valuation.
Since Bernanke’s initial comments, the Fed has attempted to calm market participants by reiterating that any decision to reduce asset purchases is “data dependent” and could well be reversed if conditions warranted. He also reiterated that a reduction in asset purchases should not be confused with monetary tightening, which he does not anticipate any time soon. Because inflation concerns are relatively tame at the moment, the primary input to the Fed’s “taper” decision will be employment indications. Current market expectations are that the U.S. unemployment rate will be around 7% when the Fed begins reducing its asset purchases.
The U.S. employment conditions continued to show sturdy resilience in June, with the non-farm payroll report beating expectations to the up side. There were 195 thousand new jobs added during the month, with significant upward revisions (+70 thousand) to prior months. The economy has added approximately 190 thousand jobs per month over the past three quarters. The unemployment rate remained unchanged at 7.6%, but was again accompanied by an increase in the participation rate and average hourly earnings.
Other economic indicators released recently have been mixed. Business activity in the service sector, as measured by the ISM non-manufacturing survey, fell to its lowest level in three years. On the manufacturing side, the ISM reading was in line with the weaker levels seen recently. However, auto sales were strong in June, with 15.2 million annualized units sold and consumer confidence holding strong. The mixed economic indications and a heightened impact of Fed decisions make the employment picture the most important economic indication in the near term.