The November employment report pushed policy expectations closer. With payrolls nipping at a positive gain and the unemployment rate falling to 10% the ducks are falling in line for the Fed to respond. But despite general opinion, payroll gains or even the turn in the trend of unemployment leaves a fairly loose indicator of when the Fed will begin hiking the policy rate.
Briefly put, the November employment report was far better than expected. Private service employment rose for the first time in a year and a half pulled by a strong rise in temporary help -- a key leading indicator of better times ahead. Another leading indicator -- the length of the workweek -- also rose strongly. The 0.2% drop in the unemployment rate stoked expectations that the trend there is turning along with payrolls. The market is getting ahead of itself as it uses the presumed turn in the unemployment trend to forecast the timing of the turn higher in Fed policy rates.
The volatility in the payroll data can lead to a long lag between the first gain in monthly payroll growth and the turn in the unemployment trend. The turn in unemployment hit a full year after the first rise in payrolls following the last two recessions as payroll gains traded off with monthly declines.
The period between the turn in the unemployment trend and the Fed's firming of the federal funds policy rate slimmed to 13 months after the 2001 recession after the 20 month span following the 1991 recession. The market presumes the Fed will be quicker during the current expansion given the lowest policy rate (0% - 0.25%) in a half century.
Certainly, Fed Chair Bernanke doesn't want to wait too long given the inflationary tone that the massive easing has brought. Moreover, the abuse former Fed Chair Greenspan has endured (the blame game) for his pause at a 1% rate after the last recession adds reason to move quickly despite concerns (Greenspan feared Japanese style deflation).
But like all recessions, this one is different. Housing foreclosures, the high unemployment rate, the lack of available credit and other indicators will help the Fed determine when policy rates need boosting. The market currently believes that an initial policy rate hike in mid 2010 seems most likely, but the future is unclear despite early signs in the labor market. The Fed will well prepare the markets for both the hike in policy rates and the draining of excess reserves from the banking system. Be patient.