What’ll the Fed do about QE3 when it meets next week? I've said before the numbers to watch are those related to employment and the two forces that have driven our anemic recovery—housing and consumer spending. If those numbers indicate the economy is gaining steam, the Fed will start tapering this month. If the numbers cast doubt on the course of the recovery, the Fed is more likely to delay a decision until December.
Last Friday the Bureau of Labor Statistics released August employment numbers, which failed to meet expectations. More disappointing, reports for previous month were revised downward.
Since April 2013, the unemployment rate has dropped only 0.2 percent, from 7.5 percent to 7.3 percent, and most of the decline is attributable to job-seekers becoming discouraged and giving up the search, not to them finding jobs. Both of these measurements show the economy remains weak.
A broader measure of the labor market is the underemployment rate, which includes the unemployed, those who've taken part-time work because they can’t find full-time jobs, and those who've given up looking. The underemployment rate has fallen only 0.2 percent since April, from 13.9 percent to 13.7 percent.
Two measurements are key to assessing the consumer sector: consumer spending and consumer confidence. Over the past four months, routine household spending by consumers has climbed from $78.00 a day to $90.00 a day, while consumer confidence has risen from 78.8 to 82.1. So, the current state of the consumer is fairly positive.
Three metrics are relevant to assessing the direction of the housing sector: home sales, housing starts, and building permits. Home sales are important because homebuyers spend money to furnish their new homes, signaling a direction for consumer spending over the near term. Since January, home sales have fallen sharply from 458,000 to 394,000.
Housing starts and building permits are indications of homebuyers’ and homebuilders’ confidence in the strength of the economy. Since January, housing starts have remained flat, drifting from 898,000 to 896,000. Building permits have risen modestly from 915,000 to 945,000. Bottom line: the housing sector has tread water this year and may be weakening.
It bears mentioning that mortgage rates jumped in late June and July after comments by Fed Chairman Ben Bernanke signaled the Fed might taper QE3 this fall. Higher mortgage rates will undermine the housing sector, and when the Fed begins tapering QE3, mortgage rates are likely to climb further. Higher interest rates are likely to dampen consumer sentiment as well.
What This Means for the Fed
All told, the economy has moved sideways this year rather than growing at a rate that would justify a decision to start tapering now. However, since the start of the 2008 financial meltdown the Fed has repeatedly overestimated the strength of the economy and it might be set to do it again.