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Don’t Get Burned By This “Fed Taper” Lie

No matter where you go in the market, all anyone wants to talk about is “The Taper” (i.e. – when the Federal Reserve will start to reduce its pace of bond purchases).

Indeed, interest in the term is reaching unhealthy levels. Don’t believe me? Just ask Google (GOOG).

Google Trends data reveals that searches for “Fed taper” barely registered a blip on the radar for most of the year. But over the last 90 days – boom! They’ve exploded higher.

As I’ve said before, we do need to get off the quantitative easing sauce eventually. But we don’t need to obsess over when it’s going to happen. And we definitely shouldn’t be making investment decisions based on the latest market predictions.

Still though, investors are looking at a projected September unwinding with anxious eyes. You’d think the world was ending. Is it?

Survey Says… September

On the heels of the Federal Reserve’s annual powwow with leading economic policy makers in Jackson Hole, Wyoming, a market consensus has emerged…

As the headline for one of the most read articles at MarketWatch.com declares, “Fed seen making first taper move in September.”

Meanwhile, a Reuters blog proclaims, “Post-Jackson Hole, Fed Septaper still appears on track.”

Hard data jives with the headlines, too…

Bloomberg reports that 65% of economists recently surveyed believe that the taper will officially be announced at the September 17-18 Fed meeting.

Apparently, it’s just a matter of formality, then. Or, as San Francisco Fed President, John Williams, told Bloomberg, “If the data continues to progress as we’ve seen, then I do agree that we should edge down or taper our purchases later this year.”

The only problem? I’m convinced that the data isn’t going to cooperate. Here’s why…

It’s All About Unemployment

The Fed has been very clear about its targets.

Inflation needs to tick above 2.5% or the unemployment rate needs to dip below 6.5% before it (finally) raises interest rates.

Regarding the former target, we’re nowhere close. “Official” inflation has been running at about 1%. And regarding the latter, the Fed expects to hit the unemployment rate target by mid-2014.

Of course, before the Fed can raise interest rates, it needs to completely end its quantitative easing efforts. So if we extrapolate backwards from the Fed’s estimates, for a September taper to make sense, the unemployment rate needs to hit 7.2% in December.

Is that even possible?

Based on the latest trends, market pundits believe so. Initial jobless claims and the unemployment rate are in a steady decline, with the latter hitting a five-year low at 7.4%.

Essentially, as long as the next unemployment report shows an improvement, the Fed should be good to go in September.

However, the less-tracked Gallup daily unemployment rate tracking survey suggests that could be wishful thinking.

It recently spiked to 8.9% – a full 1.5 percentage points higher than the government’s official unemployment reading. (Go figure. The government’s reading is the rosier one.)

As Bespoke Investment Group notes, the last three times the Gallup rate spiked, the official government rate either trended sideways or only declined modestly.

Sorry folks, but a sideways or modest decline won’t cut it. The Fed needs to see signs of a steady decline for a September – or even December – taper to be even remotely possible.

Monitor This Single Statistic

The next Bureau of Labor Statistics Employment Situation report will be released at 8:30 AM on September 6. And it’s the last unemployment report we’ll see before the Fed needs to make a decision at its September meeting.

Nothing like a little pressure, right?

In terms of a specific number to watch for in the report, we can use the Atlanta Fed’s Jobs Calculator to figure out how many jobs are needed each month to hit the Fed’s December unemployment rate target:

  • Scenario 1: Assuming no one returns to the workforce (i.e. – a market participation rate of 63.4%), the economy needs to add 163,723 jobs per month. That’s below the average of 192,000 so far this year. If the next reading checks in below this level, there’s zero chance of a September taper.
  • Scenario 2: If the market participation rate rises a mere tenth of one-percent to 63.5% (i.e. – more people return to the workforce, which would be perfectly consistent with the improving economy), the monthly jobs hurdle jumps to 206,811 per month. And that’s above the 2013 average.

Bottom line: No doubt investors are in a rush for the taper to begin. But the Fed isn’t so anxious. They’ve pretty much admitted as much, too. St. Louis Fed President, James Bullard, recently said, “We can afford to be patient.” Indeed.

For the Fed, it all boils down to the unemployment data. And based on the latest Gallup reading, the data likely won’t be good enough for a September taper. Heck, with Bernanke set to leave his post in January, don’t be surprised if he kicks the “taper” can down the road to his successor.

Ahead of the tape,

Louis Basenese