Janet Yellen is adding more dials to her labor-market dashboard, and that’s making it harder for investors to tell where she will be steering monetary policy as Federal Reserve chair.
Yellen, who has been watching an array of eight labor-market gauges in addition to the unemployment rate, introduced more complexity in an Aug. 22 speech to the Fed’s annual symposium in Jackson Hole, Wyoming. There, she discussed an index developed by economists at the Federal Reserve Board in Washington that tracks 19 indicators.
In contrast to the gains shown by the plunging jobless rate, the composite labor-market conditions index portrays a job market adrift in a narrow range since the end of the recession. Further complicating the picture, Yellen also cited a gauge from the Kansas City Fed that distills 24 numbers and depicts an improving job market.
Harry Truman “would be mad at Yellen,” if he were faced with such conflicting signals, said Brian Jacobsen at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin. The 33rd president, whose administration started measuring monthly unemployment in 1948, groused about economists who gave him on-the-one-hand-on-the-other-hand recommendations.
“He wanted a one-handed economist,” said Jacobsen, who helps oversee $232 billion as chief portfolio strategist. “She’s not even a two-handed economist. She’s an octopus, an octo-conomist. And that’s a good thing.”
Jacobsen counts himself among fans of the Fed Board’s labor-market conditions index. He said he agrees that the main jobless rate “isn’t a perfect indicator” as it can mask problems, such as high involuntary part-time employment, that signal broader weakness.
Measuring how much slack is left in the labor market is growing more difficult as the jobless rate falls, Yellen said in her speech last month. Yet it will be crucial as policy makers, who meet next week, seek to determine when to raise the benchmark interest rate for the first time since 2006.
Fed officials forecast the rate will rise to 1.13 percent by the end of next year and to 2.5 percent a year later, while investors in federal funds rate futures foresee a slower increase, to 0.725 percent by the end of 2015 and 1.725 percent in December 2016.
The disconnect shows “the public might not give enough weight to how dependent the central bank’s guidance is on both current and incoming data,” researchers at the San Francisco Fed wrote in a report released yesterday.
The Fed index that Yellen cited includes measures she monitors for a better view of the job market, such as the labor force participation rate, part-time workers who want full-time jobs, hiring, and how often workers quit their jobs.
“This broadly based metric supports the conclusion that the labor market has improved significantly over the past year,” Yellen said in her speech. On the other hand: “It also suggests that the decline in the unemployment rate over this period somewhat overstates the improvement.”
Fed officials differ on how to read the contradictory signals, and that’s not making it any easier for Fed watchers to divine the direction of monetary policy.
“You can’t blame the market that we’re confused about where to look,” said Torsten Slok, chief international economist at Deutsche Bank AG in New York. He said he has 400 client meetings a year around the world, and everywhere there is confusion about which labor-market indicators drive policy.
Role of Wages
For years the Fed talked about unemployment, then said wages would drive monetary policy, Slok said. “Now she says that this index consisting of 19 labor-market indicators is useful for understanding when they will hike rates.”
It’s no panacea to Laura Rosner, a U.S. economist at BNP Paribas SA in New York. She says the broader gauge doesn’t signal any different approach to monetary policy than the jobless rate alone.
“It doesn’t necessarily solve the problem of really reducing this complicated labor-market picture into an assessment about the degree of slack,” said Rosner, a former researcher at the New York Fed.
The Fed economists who developed the labor-market conditions index wrote in a May 22 paper that their model places greater weight on indicators that are in broad agreement. Outliers are disregarded.
The index has remained in a similar range over the past four years, and remains near its 48-month average.
The second index Yellen cited, by Kansas City Fed economists Craig Hakkio and Jonathan Willis, distills 24 employment indicators into two measures. One shows the level of activity, and another indicates the pace of change.
Those gauges “suggest the level of labor-market activity has improved substantially since early 2010 and labor-market momentum has been near historically high levels over the past four years,” they wrote in an Aug. 28 note. “The indicators also suggest the level of labor-market activity will return to its historical average level in the second half of 2015.”
For activity levels, the index is designed to show how far the labor market is from historical averages, using measures such as the main jobless rate, marginally attached workers, and the long-term unemployed. The rate-of-change gauge shows how fast conditions are changing compared with the past, using gauges such as private employment growth, hours worked, and average hourly earnings.
Willis said in an interview that he and Hakkio developed the gauge after the FOMC announced in September 2012 that it would begin large-scale asset purchases and continue them until the labor market improved “substantially.”
“We all looked around at each other and said, what does that mean? How do we measure it?” Willis said.
He said the gauge augments the main jobless rate the way that a wind chill index goes beyond just the temperature. “For the weather, if you want to know what it feels like, you need to know more than the temperature,” he said. “The temperature might be 10 below zero but you also know the wind is blowing.”
Moving toward a broader gauge wasn’t welcome for all attendees at the Jackson Hole meeting. Glenn Hubbard, dean of the Columbia University business school in New York, said he can’t see the goalposts for monetary policy, though he also is no fan of the jobless rate.
“There’s obviously a lot of slack in the labor market,” he said in an interview. “The question is how much of that can be addressed by monetary policy.”
Neil Dutta, head of U.S. economics at Renaissance Macro Research LLC in New York, said in a Sept. 2 note to clients that Yellen’s approach “doesn’t provide any meaningfully new information beyond the classic workhorse indicators.”
He said the Jackson Hole speech “left us with more questions than answers on the link between labor markets and monetary policy.”