One thing that has been made clear over the past few years is that in post-crisis America, the stock market has legs and the economy does not. Many — if not most — investors feel like equities are the best place to put money to work, and the only thing that seems able to slow down the bull market is an end to the Federal Reserve’s stimulus program.
While the Fed’s exit from unconventional monetary policy may be within sight, the central bank has made it clear that it will only wind down bond buying in the event of improvements in the underlying economy. Primarily, what this means is an improvement in labor market conditions. At the beginning of the year, the Fed set a target U-3 unemployment rate of 6.5 percent, just 1 percent below April’s 7.5 percent rate.
Delivering his May 2013 Economic Outlook earlier in the month, Richmond Federal Reserve President Jeffery Lacker pointed out that employment has grown at an annual rate of 1.1 percent since 2009. This compares against an annual growth rate of 1.7 percent between 1950 and 2000, and is a function of several long-term and structural drags that are expected to continue to negatively impact employment growth over the next few years.
For one, labor productivity, which increased at an average annual rate of 1.8 percent from 1950 to 2000, has increased at only about 1 percent since 2009. Taken together, the relatively slow growth in employment and labor productivity has put a speed limit on overall economic growth. This means that while the economy — measured against the U-3 unemployment rate — is improving, it’s doing so slowly.
As Chairman of the Federal Reserve Ben Bernanke put it in his testimony before Congress, the labor market is “improving gradually,” though “generally weak.” This ambiguous state of affairs has made it hard for Mr. Market to predict exactly what the Fed’s next move will be, probably because the Fed itself is unsure what to do next — or, if the next step is winding down bond purchases, when that will begin and how quickly.
To a large degree, the answer to this question rests on the shoulders of the labor market. The faster employment rises and the stronger the legs of the economy become, the clearer the Fed’s next moves become. Given that the markets have pretty much become addicted to quantitative easing and especially unconventional asset purchases, foresight into Fed policy could drastically reduce withdrawal pains and ease the transition away from loose monetary policy.
Labor market reports over the last few months have been analyzed to death and offer no real new insight into conditions. Fatigued analysts continue to issue warnings about putting too much weight on any individual report, and are vindicated time and time again as payroll numbers are upwardly revised by as much as 100,000 in a single month.
The reports reveal that a broad but shallow recovery is in effect with major drags coming from sequestration spending cuts, long-term worker discouragement and marginal employment, and a lower labor force participation rate. The labor force participation rate in particular — explored by Lacker in is May 2013 Economic Outlook — has been cited as a major labor market concern, although as much as half of the 2.5 percent drop since the Great Recession has been attributed to unavoidable long-term trends.
But the labor market is not without its bright spots. Housing has historically been a beacon of economic growth at the beginning of recoveries, but the unique nature of Great Recession had housing camped in the other corner. However, as bad mortgage loans are cleaned up, prices stabilize, and inventories normalize (and even narrow), the housing market continues to strengthen.
“Housing is key to closing the gap, to reemploying those who want to work,” said Mark Zandi, chief economist at Moody’s Analytics, at the presentation of a new labor market report compiled by his firm and Automatic Data Processing, according to The Wall Street Journal.