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The Fed nailed it

Janet Yellen smiling
Janet Yellen smiling

(Pablo Martinez Monsivais/AP)
Nailed it.

The Federal Reserve must be relieved.

In September, the Federal Open Markets Committee, the Fed's policy setting arm, decided not to raise its benchmark rate, which has been near zero for seven years.

Ahead of the meeting, there had been little certainty about what the Fed would do, but a good number of economists believed that the economic data had improved enough to compel the Fed to raise rates.

And then on Friday, we got the first jobs report since that report, and it simply awful all around.

In September, the US economy added 142,000 jobs, fewer than expected, while the August report was also revised down to 136,000 from 173,000, making it the second-worst month of 2015. The unemployment rate held steady at 5.1%, a seven-year low, but the labor-force-participation rate fell to a 38-year low.

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Perhaps most discouragingly, wage growth was flat in September.

To be sure, one or two months of data do not make a trend, but the Fed's decision to be cautious certainly looks like the right one.

Priya Misra, head of global rates strategy at TD Securities, told Business Insider following the report:

"The Fed has been vindicated for waiting. They wanted to see what the impact of the tightening in financial conditions and weakness abroad would be on the US. Today's report was unequivocally weak. It's only one data point, so it's not clear that it is the start of something more ominous, but the Fed should wait for more data."

And although the Fed is fixated on the incoming economic data, it's also clearly paying just as much attention to the evolution of longer-term trends.

Screen Shot 2015 10 02 at 4.19.29 PM
Screen Shot 2015 10 02 at 4.19.29 PM

(Deutsche Bank)

The Fed's mandate for setting monetary policy rests on two pillars: full employment and stable inflation.

On the latter, the Fed had said it was confident that inflation would progress towards its 2% target.

The labor market, however, is approaching the Fed's goals, even with Friday's less-than-stellar report.

In a speech last week, Fed chair Janet Yellen said that, "Although other indicators suggest that the unemployment rate currently understates how much slack remains in the labor market, on balance the economy is no longer far away from full employment." An assessment that is unlikely to get a material revision after Friday's numbers.

But in the view of chair Yellen, there are still structural problems to overcome, with Yellen saying last week that, "On a cyclically adjusted basis, the labor-force-participation rate remains low relative to its underlying trend, and an unusually large number of people are working part time but would prefer full-time employment."

In a note to clients on Friday, Deutsche Bank's Joe Lavorgna wrote:

While some metrics on Yellen’s dashboard of labor indicators are either in line with or slightly better than their levels at the beginning of previous Fed hiking cycles, the Fed is now in a difficult position because the first condition that needed to be met for liftoff was further improvement in the labor market.

The September employment report did not meet this criterion. Hence, the characterization of labor market conditions in the October meeting statement is sure to be less upbeat than it was in the September statement.

As Business Insider's Mike Bird noted in August, the Fed appeared at risk of repeating a mistake it made in 1937, when it hiked rates amid a relatively good-looking economy that turned out not to be ready for tighter policy. That decision turned out to be premature and was followed by a 50% crash in stocks the following year, and a resulting climb in the unemployment rate.

And now outside of its labor market and inflation concerns, the Fed is also worried about a slowing global economy, and how the pace of the dollar's appreciation is already tightening financial conditions.

attached image
attached image

(Capital Economics)

There are now any number of guesses on whether the Fed could — or should — still raise rates this year.

LaVorgna wrote that Friday's report "lowers the probability" of a December hike.

RBC Capital's Tom Porcelli wrote in a note that it would take a third weak jobs report to throw off the Fed.

Bank of Tokyo-Mitsubishi's Chris Rupkey gave up on any hike altogether.

But the September jobs report confirmed that the labor market has not seen the further improvement the Fed wants.

And, at least for now, the Fed has been vindicated.

NOW WATCH: Fed's Bullard explains the problem with keeping rates at zero forever



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