(By Mani) The employment and ISM reports for August push the Fed toward further quantitative easing, or QE3, at the upcoming Federal Open Market Committee (FOMC) meeting on Sept.13.
The unemployment rate fell to 8.1 percent from 8.3 percent, but for the wrong reason—a decline in labor force participation that outweighed the drop in household-survey employment. Last year, the FOMC discounted declines in the unemployment rate when they were accompanied by a lower participation rate.
The payroll data appear roughly consistent with the soft third quarter output growth, and for the Fed, that growth pace does not represent the substantial and sustainable improvement in activity necessary to head off further accommodation.
"We now anticipate an announcement of another round of quantitative easing at the FOMC meeting on September 13th. We expect the easing will take the form of a six-month program of at least $500 billion, primarily focused on Treasuries," UBS analyst Maury Harris wrote in a note to clients.
The QE3 is preferred to be an open-ended affair and contingent on economic conditions rather than announcing a single amount. However, the fact that Chairman Ben Bernanke downplayed the impact on market functioning that further quantitative easing might have suggests that the Fed will not alter the mechanics of the announcement too much.
"We also expect the FOMC extends their rate guidance into 2015," Harris said.
In addition, officials may add additional language indicating that policy will stay "highly accommodative stance ...even as the recovery progressed." In other words, the eventual pace of tightening will be slow.
"Despite a weak August jobs report, we are maintaining our already modest growth forecasts (real GDP growth of 1.5% in Q3 and 1.8% in Q4)," the economist added.
Last week, the U.S. government said the payrolls increased 96,000 in August compared to the consensus view of 130,000, while July number was revised down to 141,000 from 163,000, and June to 45,000 from 64,000. The private sector added 103,000 jobs in August, marking 30 consecutive monthly gains which have added 4.6 million jobs.
Private payrolls rose 226,000 per month in the first quarter, slowed to 88,000 per month in the second quarter, and reaccelerated only to 133,000. Household incomes got no support from average hourly earnings, and the workweek was unchanged at 34.5 hours.
The employment report suggests only a very limited bounce-back in hiring after the rapid slowing in the second quarter.
"As such, we now forecast new easing at the September 13 FOMC meeting. That easing will probably take the form of a longer-term commitment to hold the funds rate at extraordinarily low levels as well as a new round of Treasury (and perhaps MBS) buying by the Fed," Harris added.
In the next two days, the highlight should be the FOMC, as growth data are likely to look mixed, with a solid rise in retail sales but a sharp decline in industrial production.
"We forecast a slightly wider trade deficit to start Q3, and little change in consumer confidence survey at the end of Q3. The headline readings in the PPI and CPI will probably be up sharply, led by higher gasoline prices. We forecast a relatively modest gain of 0.2% in the core CPI and 0.1% in the core PPI," Harris noted.
In Europe, Draghi has effectively confirmed that the European Central Bank (ECB) is ready to act as a lender of last resort, only conditional on countries submitting to the "strict conditionality". Once the German constitutional court ruling and the results of the Spanish banks audit are out, the stage will be set for an aid request from Spain.