MNI EXCLUSIVE: Fed Edges Closer to 'Substantial Progress' Mark

The Federal Reserve is likely to define "substantial further progress" toward its maximum employment goal, part of its criteria for tapering QE, as just over halfway between where the labor market stood in December and policymakers' judgement of full employment, former officials tell MNI.

"The implicit (jobless rate) target is under 4% so you judge it accordingly -- if Powell's adjusted unemployment rate makes up half of that, I think he's entitled to say substantial progress," former Richmond Fed President Jeffrey Lacker said in an interview.

How quickly the central bank is able to claim it has crossed the threshold depends on forecasts for how fast the job market will rebound, and these have become increasingly bullish, both former and current officials acknowledged.

Seth Carpenter, who spent 15 years as an economist at the Fed Board, told MNI he thinks the economy will generate 1 million jobs or more a month consistently in coming months, allowing policymakers to claim at least a partial mission accomplished by fall. March saw an increase of 916,000 jobs that many believe is the start of a spring and summer surge.

Powell will use his prominent Jackson Hole speech in August "to separate out hiking from tapering" in order to ease markets into the idea of a shift in QE policy, Carpenter said.

Fed Chair Jerome Powell and other policymakers have thus far been reluctant to flesh out the verbal forward guidance on asset buys, in part for fear of a repeat of the 2013 "taper tantrum" where a mere mention of possible QE reduction led to a sharp tightening of financial conditions. Still, Powell recently told 60 Minutes the economy was now at an "inflection point."

"I don't think enough people in markets have caught on to the change in tone," Carpenter said.

Powell has emphasized that a sharp drop in the official jobless rate to a still-elevated 6% masks a decline in participation during the pandemic which brings the actual rate closer to double digits.

HOT SUMMER

Carpenter is not alone in thinking March's pace of job creation could be repeated several times over the summer.

Kevin Kliesen, an economist at the St. Louis Fed, told MNI last week it would take about a year of monthly job gains circa 700,000 in order to make up for the 8.4 million jobs deficit caused by the pandemic recession. He thinks this is within reach just based on current forecasts for GDP to return to pre-pandemic levels this quarter or next.

In particular, Kliesen will be tracking hard-hit sectors such as leisure and hospitality, which would need to add around 260,000 jobs per month to regain its pre-pandemic level of employment over the next year. Leisure and hospitality added 280,000 jobs in March.

"At some point you just have to say the data are coming in strong, our forecasts look really good, we know there are risks out there, but our baseline forecast which we hang our hat on is a pretty strong economy this year," he said.

Rapid vaccinations and a robust fiscal policy, coupled with the Fed's ongoing support for the economy in the form of near-zero interest rates and USD120 billion in monthly QE, have sharply boosted optimism about how quickly the economy can return to normal -- and how soon the Fed's twin goals of stable prices and full employment might be met.

INFLATION STRIDES

Strides in employment may be more relevant for tapering than inflation at this point, Fed sources say, because inflation and inflation expectations have already ticked perceptibly higher since December, in accordance with the Fed's desire to engineer an overshoot of its 2% inflation target in order to lift long-run expectations back to that target.

The Fed's preferred inflation measure, the personal consumption expenditures index, stood at 1.2% in December, and has since climbed to 1.6%. The Cleveland Fed Inflation Nowcast expects PCE inflation to accelerate to 2.3% in March and 2.9% in April. The Treasury market's five-year breakeven rate has jumped a full percentage point since the start of the year to around 2.55%.

Importantly, Fed officials are no longer expressing major concerns about long-term scarring effects on the job market or troubles boosting the participation rate again once the Covid cloud has lifted.

Eric Swanson, a former senior advisor to the San Francisco Fed and ex-Fed board senior economist, told MNI the Fed's framework shift toward a more inclusive definition of full employment means it will be paying a lot more attention to the black and Hispanic jobless rates.

But that may apply more to eventual interest rate hikes than tapering. "They're probably just going to hang out until the official unemployment rate is closer to 5%," said Swanson referring to QE.