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Today's August employment report matters. Not only is it a key indicator of the health of the U.S. economy in its own right, but it's the most important data Federal Reserve policymakers will see before the September meeting of its monetary-policy committee, the Federal Open Market Committee. The consensus view is that the FOMC will decide to begin scaling back its $85 billion-per-month bond purchases.
The headline numbers look encouraging: The economy added 169,000 jobs in August, and the unemployment rate fell by 0.1 percentage points to 7.3%, the lowest rate since December 2008 (one year into the Great Recession). However, The Wall Street Journal's Phil Izzo does a good job of explaining why the unemployment rate dropped for the wrong reasons:
The drop in the main unemployment rate was driven almost totally by negative factors. The number of people employed fell by about 115,000. The only reason the rate declined is that the overall labor force dropped by a larger 312,000, a possible sign of discouraged long-term jobless dropping out.
The labor force participation rate, which is the percent of the population either working or looking to work, took a tumble to 63.2% -- its lowest level since 1978.
Equity investors appear to be giving the report the thumbs-down: The S&P 500 (SNPINDEX:^GSPC) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES:^DJI) are down 0.81% and 0.95%, respectively, as of 10:05 a.m. EDT.
The last time the unemployment rate was 7.3% and declining was in January 1993; at that time, the economy was recovering from the short-lived July 1990 to March 1990 recession. By the end of 1993, the jobless rate had fallen to 6.5%, which happens to be the threshold at which the Fed now says it will begin considering a rate hike. One year later, unemployment was down to 5.5%.
The 1990-1991 recession was a lot shorter and less traumatic than the Great Recession, which has been over for four years now, but the example may help to illustrate why the fixed-income investors appear to be pricing in rate increases on an accelerated calendar compared to the forward guidance the Fed has provided. Indeed, Fed funds futures prices now imply a first hike in October 2014, whereas the Fed policymakers have indicated they do not expect this to occur before 2015 -- even late 2015.
What does this mean for stocks? While recent economic data has been encouraging, today's employment report will not be what the Fed is looking for if it is seeking confirmation for a decision to taper its bond-buying program. Either way, investors should expect volatility in the short term; however, the longer-term outlook suggests the U.S. economy is continuing to heal, which is overwhelmingly positive for corporate earnings and thus stock prices.
Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.