The employment report is expected to be weak. Wall Street now expects a nonfarm gain of just 71k with, considering the ADP private payrolls loss of 123k, a strong possibility of a negative number. Of course, while this would be a disappointment, it is not entirely unexpected given the winter Covid-19 wave and the associated increase in business restrictions. The Fed has already been clear that they expect to look through the near-term weakness especially now that fiscal policymakers stepped up to the plate to provide the needed short-term support for the economy.
The Fed is instead focused on the medium-term policy outlook and sending a lot of mixed signals on plans for the asset purchase program. On one end of the spectrum, St. Louis Federal Reserve President James Bullard said (via Marketwatch) that it was too early to discuss tapering asset purchases even though he expects possibly higher inflation. Others though are warning that tapering could happen this year. See for example this interview with Atlanta Federal Reserve President Raphael Bostic:
Atlanta Fed’s Bostic: Later this year, the economy might show “a lot more strength than I think some people are projecting.” pic.twitter.com/1diqqj2TD7
— After the Bell (@AftertheBell) January 7, 2021
Why are we hearing such mixed signals? I think the messaging reflects the considerable uncertainty regarding the economy in the second half of the year. Bostic, for example, clearly is considering an outcome very different from that expected by the median FOMC participant. This isn’t about Fed officials predicting an early tapering. It’s a reminder that the path of policy is data dependent. It’s about preparing market participants for the possibility that the economy rebounds sufficiently quickly to justify a tapering late this year or early next. The combination of rapid growth in the third quarter, the fiscal support for the economy in the winter, the pent-up demand that could be satisfied from savings, and the vaccine open the door for upside risks to the forecast that are too real to ignore.
From my perspective, I think it is notable that Fed speakers are sending these signals in that it reminds us how to read incoming data. The Fed is committed to easy for longer policy, we should expect that as the baseline. But what are the balance of risks to the baseline? When Fed speakers start to emphasize the possibility of early tapering, they are signaling a greater confidence in upside risks. It also follows that an early tapering would be associated with economic conditions that pull forward expectations of a rate hike.
One final point: The Fed is obviously aware that with the Democrats taking the Senate there may soon be much more fiscal stimulus than expected. A lot more. That must play into a sense of growing upside risks to the outlook.
Bottom Line: Weakness in the employment report is expected. Focus instead on assessing the risks to the back half of the year.