While quite a bit has happened in the global markets since we broke for summer, the one topic that spanned the summer was the focus on the Federal Reserve tapering their Asset Purchase Program. If you recall, the Fed has been purchasing $45 billion in U.S. Treasury securities and $40 billion in Mortgage-Backed Securities per month since late 2012. Despite widespread belief that the Fed would begin to pare down this pace of purchases in their Sept. 18 decision, the Fed sent shock waves through the market by holding course. Their reservations were two-fold, citing a lack of sufficient growth in the economy to stand on its own as well as the near-term U.S. fiscal outlook. Given the current U.S. government shutdown centered around the Affordable Care Act, the Fed has the right to be concerned about the fiscal outlook but in the rest of this update we will look at a couple of the key macroeconomic variables that the Fed is concerned about independent of the Washington situation.
The Fed's balance sheet expansion was focused on stimulating growth in the economy and avoiding the catastrophic effects of deflation. To date, the three rounds of stimulus by the Fed have resulted in a balance sheet expansion of approximately $3.7 trillion. While this has spurred an equity markets surge of 150 percent since March 2009, the inflation situation has been much less encouraging. With long-term desires for the core personal consumption expenditures (PCE) price index to trend towards two percent, 2013 has seen year-over-year price growth hovering around one percent. This has led to a great deal of caution as the Fed looks to reduce the stimulus machine; the purchases have not made their way through the real economy with respect to price levels as they have in the financial markets.
Another area of grave concern at this time is the labor market situation. You can see in the adjacent chart that the situation has certainly improved over the last three years but the troubling reality here is that a weak participation rate is masking a labor market that does not look incredibly different than it did in 2012. In fact, payroll growth has slowed over the last three months and the labor force participation rate is at its lowest levels since 1978. Anecdotally, if the labor force had held constant in September, the unemployment rate would have crept up to 7.5 percent as opposed to falling to 7.3 percent. The conflicting signals in the labor market are causing a great deal of uncertainty for the Fed's forecasts on tapering and the Fed is scratching their head over what to do about this stubborn trend in the participation rate. Either way, expect the taper rhetoric to continue to dominate the headlines, certainly through the next policy meeting scheduled for Oct. 29-30.