Fed Announces Taper as Payroll Growth Accelerates and Inflation Persists

Key Takeaways:

• The Federal Open Market Committee (FOMC), following its November 2-3 meeting, announced a reduction of $15 billion per month to the pace of its net asset purchases in November and December. According to their statement, the economy has made “substantial further progress” toward the Committee’s goals of maximum employment and price stability and that a similar pace of tapering “will likely be appropriate” for future months, though this is subject to change based on economic conditions.
• Nonfarm payroll employment increased by 531,000 in October, and the reports for August and September were revised upward by a combined 235,000 jobs, according to the Bureau of Labor Statistics (BLS). Leisure and hospitality gained an additional 164,000 jobs and residential construction employment (including specialty trade contractors) rose by around 11,000, the largest gain since July. Average hourly earnings were up 4.9 percent over the year, an acceleration of three-tenths from September. The household survey showed the unemployment rate declined by two-tenths to 4.6 percent, though the labor force participation rate was flat at 61.6 percent, which is about 1.7 percentage points lower than in February 2020.
• The ISM Manufacturing Index declined three-tenths to 60.8 in October (any reading above 50 indicates expansion). The new orders index fell 6.9 points to 59.8, the lowest level since June 2020. The supplier deliveries index rose 2.2 points to 75.6, the highest level since May, indicating that delivery times remain slow. The non-seasonally adjusted prices index increased 4.5 points to 85.7, the largest monthly increase since January. The ISM Services Index jumped 4.8 points to 66.7, the highest level on series record, reflecting more than 6 point increases in the business activity, new orders, and supplier deliveries indices. The prices index rose 5.4 points to 82.9, the highest level since 2005.
• Private residential construction spending declined 0.4 percent in September, according to the Census Bureau. Spending on single-family and multifamily construction fell 0.6 percent and 0.3 percent, respectively, while spending on improvements was down 0.1 percent.
• Light vehicle sales rose 6.0 percent to a seasonally adjusted annualized rate (SAAR) of 13.1 million units in October, ending a five-month streak of declining sales, according to Autodata.
• Factory orders grew 0.2 percent in September, the fifth straight monthly increase but the slowest growth rate during that time, according to the Census Bureau. Excluding transportation, new orders were up 0.7 percent as transportation orders fell 2.3 percent. Orders of nondurable goods and core capital goods each increased 0.8 percent. Shipments rose 0.6 percent and inventories increased 0.8 percent, though the number of unfilled orders also expanded by 0.7 percent.
• Nonfarm business productivity fell 5.0 percent annualized in Q3 2021, the sharpest decline since 1981, according to the preliminary estimate from the BLS. The annualized data showed real output rose by only 1.7 percent, while total hours worked jumped 7.0 percent as unit labor costs surged 8.3 percent.

Forecast Impact:

The employment report showed broad-based gains across industries and was in line with our expectations. We expect the release to have minimal effect on our current Q4 economic forecast. However, the participation rate remained stubbornly low as the civilian labor force gained only 104,000 workers, a trend that, if persistent, could lead to an eventual downward revision to our 2022 GDP forecast due to a more limited labor supply next year than we are currently anticipating. Further, coupled with rising wages, the decline in productivity points to some upside risk to our inflation forecast. However, the report should be interpreted with caution, as the metric is notoriously volatile and is likely impacted by ongoing pandemic-related compositional shifts in the labor market.

Many of this week’s indicators, from slowing residential construction to rising unfilled factory orders and slower delivery timelines, continue to reflect the persistent supply chain bottlenecks limiting economic activity. Inflationary pressures remain evident in nearly every economic report, prompting the Federal Reserve’s taper announcement, the timing of which was already incorporated into our forecast. However, the surprise jump in the services index suggests that declining virus cases may accelerate the pace at which consumers substitute their spending away from goods and into services, which could eventually impact our forecast on multiple fronts. First, consumption growth, which we had expected to be weighed down by goods shortages, could be higher than expected if consumers are willing to spend on high contact services instead. Further, lower demand for goods may allow businesses to restock inventories somewhat faster than expected and could partially alleviate some price pressures, though we continue to expect inflation to remain elevated.

Nathaniel Drake
Economic and Strategic Research Group
November 5, 2021

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