As usual the Federal Reserve, when dealing with the public, is confident it is dealing with subhuman idiots, as only its Wall Street masters are clever enough to read between the lines of perpetual fraud spewing forth from the Marriner Eccles building. Maybe those who buy into this "bull market" with both hands potentially fall into that category, but others, like ConvergEx's Chief Market Strategist Nicholas Colas, are still capable of rational thought. Today, the Fed came out with its latest bout of projection insanity. It is hereby totally refuted.
Fed Reality Check – Analyzing Recent (Lofty) Labor Market Expectations
Summary: According to the minutes from its latest Federal Open Market Committee (FOMC) meeting in April, the Fed predicts unemployment will fall to 9.3% this year followed by 8.2% in 2011. In order to reach these projections, by our calculations, the economy will need to add 385,000 jobs each month from now through December 2010 and 323,000 each month from now through December 2011. These already seemingly high numbers appear even more extraordinary when taking the government’s temporary hiring of census workers out of the equation. Also, in the 3 months since the FOMC’s prior meeting, unemployment projections became more optimistic: The average expected unemployment rate for this year dropped 0.3 percentage points from 9.6% to 9.3%.
There are experts in every field. College professors, sportswriters, doctors, lawyers, etc. They all give advice or guidelines, which we generally accept as fact and/or follow because they know more than we do on a given subject. This is not to say they’re never wrong.
As an example, Sports Illustrated polled its “all-star lineup of college basketball writers and editors” for their final four picks prior to March Madness a couple months back. When all was said and done, the selected “all-stars” were collectively 34% correct in their predictions, while one gentleman was 0 for 4 in his picks. Safe to say, you might expect more than 34% from the experts.
And what about the Preakness Stakes? After the Derby, Super Saver was a 5/2 favorite among the “expert picks around the country,” but as is not uncommon, the favorite didn’t win and in this case the victor was Lookin at Lucky, who went in with 3/1 odds.
Similarly, the economists at the Fed are considered to be experts on the economy. Just like other experts, part of their mission is to make forecasts for the rest of us, given that their knowledge on the economy, by virtue of their jobs, is greater than ours. Not to say we can’t or shouldn’t evaluate the accuracy and feasibility of their conclusions…
Conclusions such as unemployment rate predictions, which, in our opinion, are the most critical of the FOMC’s collection of economic indicator forecasts. While the Fed’s mandate is to create both price stability and full employment, excess capacity is presently taking care of price stability, so employment growth is the larger unknown in the foreseeable future. Therefore the pace of job creation will likely also inform the Fed’s thought process on how/when to raise rates. That being said, the latest “expert” predictions on the labor market – coming from 17 Federal Reserve Governors and Reserve Bank presidents – show they expect on average an estimated unemployment rate of 9.3% for 2010, which will fall to 8.2% by the end of next year.
Below we outline our use of a yearly one percent labor force growth rate to estimate the number of jobs that need to be created to achieve the Fed’s predicted jobless rate. Why one percent? For starters, one percent is the historical annual population growth rate of the U.S. The labor force rate, however, might be even higher since we do not know how fast discouraged workers will come back into the workforce looking for jobs. Right now they are not looking for work so they are not considered part of the workforce, but if/when things improve, they will reenter the labor force and that will tend to increase the unemployment rate.
The closest we have recently come to 9.3% unemployment was a 9.4% rate in May 2009, when there were a total of 131.2 million people employed in the U.S. Factoring in an annual increase in the labor force of one percent, payrolls would need to reach 133.2 million by this coming December to reach the Fed’s projected 9.4% unemployment rate. With 130.2 million people presently employed, that works out to an addition of 385,000 jobs in each month, May through December – and that’s just to reach 9.4%. The low-end Fed projection is 9.3%. Considering the economy added 290,000 jobs (more on this later) last month, 385,000 seems a touch ambitious to say the least.
Even more extraordinary are the numbers it will take for unemployment to fall to the Fed’s target 8.2% rate by December 2011. February 2009, when there were 132.8 million people with jobs, was the last time unemployment was at 8.2%. Again factoring in a yearly one percent increase in the labor force, the economy needs an additional 323,000 jobs each month for the next 20 months to hit the Fed’s average estimate.
In the past 2 decades (see Chart 1 ) the economy has only added 385,000 jobs on 8 separate occasions and a monthly addition of 323,000 or more jobs has only occurred 10% of the time. Lofty expectations, right? Well, unfortunately this year there’s another factor that comes into play – the government’s temporary hiring of workers to conduct the decennial census.
Though on select occasions such temporary hiring has had a positive effect on net payrolls, it has overestimated permanently employed workers in each of the 2 latest months reported (March and April). Chart 2 shows net jobs added in each of the past 12 months, with both the BLS monthly reported number as well as nonfarm payrolls excluding the impact of government jobs. The jobs picture has undoubtedly picked up this year, but assuming a majority of the government’s hiring in the past 2 months has been of temporary census workers, March’s addition of 230,000 jobs is really only 174,000 permanent jobs, while April’s 290,000 increase in payrolls totals 231,000 when excluding the 59,000 workers hired by the government.
We would make a few comments on the construction of the Fed’s predictions. Economic projections are submitted by a total of 17 people – the Federal Reserve Governors and the Reserve Bank presidents who vote on interest rate policy at the FOMC meetings. The range of projections that is quoted in the press, or the central tendency, is comprised of 11 predictions, as it excludes the 3 highest and 3 lowest estimates. The actual range for all 17 votes in many cases shows much more variety (i.e. uncertainty). For example, the current central tendency for unemployment is 9.1% to 9.5%, while the actual range is 8.6% to 9.7%.
When compared with projections from January’s FOMC meeting, the most recent estimates show the Fed’s labor market expectations have improved. At the beginning of the year, all but 2 of the 17 voting members expected the unemployment rate would be at a minimum of 9.4% by the end of 2010. Now, the majority of votes (12 of 17) calls for a rate of 9.3% or lower. Projections for 2011 were for the most part unchanged.
Perhaps net monthly nonfarm payroll increases thus far in 2010 influenced slightly more optimistic projections from the Fed - which is understandable – but the sheer number of additional jobs that need to be created to hit these projections seems a bit out of reach given the lack of a specific blueprint for where these jobs will come from. On the other hand, suppose the Fed were to choose a more pessimistic route and suggest unemployment were going higher. Imagine the effect that might have on a company’s hiring plans.
We look forward to the next jobs report in hopes for another addition of 200,000+ permanent, non-census related jobs, as any increase in net jobs is a plus for economic recovery. While skeptical the economy will month-after-month add the jobs necessary to hit the Fed’s proje cted jobless rates, it appears the worst is behindus in terms of the employment picture – it just may be a longer road to recovery than many anticipate.
Finally, just as proof that even the Fed – like all other “experts” – has gotten it wrong before, we make one final note. In June 2008 the Fed predicted 5.3% to 5.8% unemployment for 2009. Even after the Lehman collapse, the Fed vastly underestimated the severity of the recession, forecasting 7.1% to 7.6% unemployment in 2009. The lowest jobless rate in 2009? 7.7% in January. Which – as we are all aware – escalated to +10% by October.