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The sprint for substantial further progress

| April 9, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The Fed has said it plans to keep securities purchases rolling until the economy has made “substantial further progress” toward maximum employment and 2% inflation.  But officials have been purposefully vague about exactly what that means. The economy is reopening, and we are likely to see sharp upward movement in both employment and inflation over the next several months.  At least on the labor side, we could see substantial further progress by August.

Starting Point

The FOMC rolled out the “substantial further progress” forward guidance language for its balance sheet strategy back in mid-December.  The starting point for benchmarking further progress should be the November data.  The labor market then had rebounded from the economy’s low point in April but stood short of the mark before the pandemic began (Exhibit 1).

Exhibit 1: Initial Progress

Source: BLS, ISM, NFIB.

The labor market still had made good progress by last November.  In fact, most of the indicators were more than halfway back to their pre-pandemic levels.  However, as Chair Powell and other Fed officials have made clear, the economy was still in a very deep hole, with payroll employment still 10 million shy of the February 2020 level and the unemployment rate several percentage points higher.

The economy made only limited progress through the winter as the pandemic ratcheted up sharply, forcing many states to reimpose restrictions on business activity.  Over the past month or two, however, the labor market appears to have gained considerable ground (Exhibit 2).  The improvement is likely to gather momentum in the spring, as vaccinations are allowing for the removal of business restrictions in a number of states already, with others likely to follow suit once cases and hospitalizations decline further.

Exhibit 2: Further Progress

Source: BLS, ISM, NFIB.

Progress since November

For each variable, we can assess the “progress” made since the FOMC’s initial forward guidance offering.  For payroll and household employment, the gains have been limited.  There was not much growth at all in the winter months, followed by a strong payroll advance in February and an explosive rise in March.  As a result, payroll employment is now about 8.5 million short of the pre-pandemic level, while the household survey gauge of employment is 8 million short.  The unemployment rate has dropped by another 0.7 percentage points but remains 2.5 percentage points above the February 2020 reading.  Involuntary part-time workers have also continued to move back toward levels seen before the pandemic.  The one variable that has not yet made up significant further ground is labor force participation, as the LFPR in March was unchanged from November.

The continued low level of labor force participation is creating a shortage of available workers as firms look to staff back up. The JOLTS measure of job openings has surged in recent months and, as of February, exceeded the readings just before the virus hit.  Similarly, the ISM non-manufacturing employment index and the NFIB measure of small business hiring plans both are above their February 2020 levels. Even as employment levels are still depressed, from the perspective of prospective hirers, the labor market looks very tight, remarkably similar to what we were seeing prior to the pandemic, when the unemployment rate was sitting at 50-year lows.  Another marker is online job postings.  The job-search site Indeed reported that job listings as of April 2 were 16.4% above the level on February 1 of last year.

Potential workers look likely to flood back into the job market as soon as more people are vaccinated and feel safe returning to the workplace and as soon as schools fully reopen, freeing parents to work outside the home daily.  The former should be accomplished within the next two months.  The latter should also be mostly achieved by then, though for a handful of big-city school districts, a return to full in-person learning may have to wait until the beginning of the next school year.  A third key development will be the expiration of supplemental unemployment benefits in early September.  Currently, with an extra $300 per week in payments available, there are still millions of lower-wage workers who are financially better off collecting benefits than going back to their former jobs.  This is undoubtedly exacerbating the shortage of available workers that firms are currently facing.

Defining “substantial”

Fed officials have been intentionally vague about what would constitute “substantial further progress.”  Initially, narrowing close to half of the November 2020 employment shortfall relative to February 2020—around 5 million jobs—seemed like it might be enough.  After listening to policymakers over the last three months, it might take even more progress to satisfy “substantial.”  However, the March payroll jump, over one million including revisions, represents a mere down payment on what should be a massive hiring spree in the spring.  Payrolls should advance by at least a million a month on average over the next three to four months.  A run of that magnitude would bring the level of employment to a point where Fed officials would have an increasingly hard time denying “substantial further progress.”  In fact, the the labor market will likely meet the FOMC’s standard for tapering by the summer—maybe August or at the latest September—though the inflation side of the equation will be a more complicated assessment and a discussion for another day.

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