Why the Fed Needs to Taper Now in Spite of Weak Jobs Report

By George Leong

The Federal Reserve will need to make a big decision soon, prior to its Federal Open Market Committee (FOMC) meeting in mid-September, regarding the continuation of its monetary policy. Before Friday’s non-farm payrolls report, the decision was somewhat easy to make on the heels of positive economic data and a good second-quarter gross domestic product (GDP) reading. The initial claims for the most recent week were the lowest since before the recession.

The futures market was betting on the Federal Reserve beginning to rein in its bond buying at the September meeting; even the Federal Reserve’s Beige Book pointed to tightening.

But then the market was surprised when the non-farm payrolls showed a muted 169,000 new jobs in August and worse yet, the July reading was revised downward by 36% to a horrible 104,000. What the heck happened with the U.S. Department of Labor? Maybe a case of sticky fingers?

The unemployment rate did fall to 7.3%, but that was driven by a decline in the labor force participation rate to 63.2%.

The Federal Reserve and Mr. Ben Bernanke now have some serious thinking to do. Pull back on bond purchases and this could hurt the economy, given the jobs report.

The futures market fell on the report, betting the Federal Reserve’s tapering may not begin until the October meeting. Of course, continued weakness in the jobs market could mean tapering could get pushed back until the December meeting, which coincidentally will be the final meeting with Bernanke at the helm of the Federal Reserve, and we know he probably would want to start the process in his term.

For the economy, the report is not good news, as it suggests continued sluggishness in the U.S. economy. In a healthy economy, you see steady jobs growth at much higher levels than what we are seeing. The impact of the weak jobs report will likely be felt on the economy, especially in the retail sector, as consumers hold back on spending. Leading up to the key holiday shopping season—that’s not good.

So now, despite trillions of dollars of quantitative easing, the U.S. economy is growing at just over a mere two percent, corporate America can’t generate strong revenue growth, and people are suffering looking for jobs that do not appear to be there. Of course, there’s also the lower quality of the jobs growth that entails many lower-paying service jobs and not as many highly skilled or education-based jobs that the government would want to see.

In my view, the Federal Reserve should begin to taper a bit in September and see what the impact on the stock market and economy are. The fact is there are enough positives to begin the tapering process. We don’t need to see sustained jobs growth to begin the tapering.

So while I would want the Federal Reserve to begin tapering in September, there’s a chance that it won’t happen until at least October. The bottom line is: bond yields will inevitably head higher this year, so it may be time to start looking at bonds.

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