America's job report seems to be one of the most sought after indicators of economic and business success. In fact, a glance at the Federal Reserve's quantitative easing policy sheds light on the importance of whether you or your neighbor wake up for work each morning.
Government tied to jobs
Under Federal Reserve Chairman Ben Bernanke, the Fed continues to pour $85 billion into the marketplace each month through its bond-buying stimulus efforts. To date, some analysts estimate that bank reserves increased nearly $800 billion since September 2012, while only $80 billion is circulating in the economy.
So, 90% of cash is sitting on balance sheets — what will occur when the cash circulates into the economy? Scary thought. Depending on political and economic perspectives, this phenomenon could indicate why the Fed wants to continue its program.
When determining when it will scale back its bond-buying program, the Fed looks at many sources, notably the jobs report. The monthly document provides information about the strength of American businesses via unemployment or hiring rates and the economy at large. The Fed uses the data, in part, to determine the strength of the economy and the strength of consumerism — spending. Unfortunately, the effort to promote spending and consumption to drive the economy, not investing or saving (to invest in more productive opportunities at a future time), defies historical precedent.
The Great Depression and Financial Crisis
As inferred by the stimulus effort, today's culture teaches that saving or investing does not promote long-term growth. Rather, it teaches that consumption is the key to prosperity. Under this mindset, more spending stimulates production and growth.
However, as seen in the images below, investment plummeted nearly 80% to its low during the Great Depression.
At the same time, Americans reduced their spending (about 77%).
The 2008 financial crisis also realized a massive decline of investments (over 25%).
Unlike the Great Depression, though, consumer spending barely declined (only 3%) during this period. And, partly fueled by the bond-buying program, it continues to expand.
During the Depression we see that spending decreases were nearly identical to investment decreases; during the financial crisis, the spending was not cut. Though these two factors do not exist in a vacuum, the formula is not good. Interestingly, economists credit Germany's high savings rate as a key reason the country was able to rebound from the effects of World War II.
So, with rising spending, especially in proportion to investments, new territory awaits.
Why jobs matter
A pullback on the stimulus efforts will undoubtedly shock the market. For example, earlier this summer when investors anticipated that the Fed would reduce its quantitative easing policy in July or September, real estate markets reacted — and fast. The average fixed rate 30-year mortgage increased from 3.54% in May to 4.46% in August. And since the Fed did not begin tapering its bond-buying program, the rate is declining; it's now at a four-month low of 4.13%.
The daily impact
Until the Federal Reserve thinks that the American economy is stable enough to handle tapering of its financial policy, expect what we've been seeing: uncertainty. For instance, the S&P 500 traditionally moves in correlation with jobs report data; if expectations are met or exceeded, the index increases. However, even when the Department of Labor announced job figures below estimates on Oct. 22, the S&P 500 reached a new all-time high.
The reason is that investors now expect quantitative easing measures to continue.
Plus, due to the government shutdown earlier this month, the new job report will post less optimistic results than originally anticipated. So, quantitative easing will likely continue (some estimate until March 2014).
A closing thought
Behind all of the detailed political agendas and heavy financial calculations is a simple word: jobs. Until jobs reach what the Fed considers safe levels and until long-term investing and saving align more clearly with spending, expect the jobs report to continue to be a driver of the Fed's decision making policy. Until then, expect the unexpected.