Drop in jobless claims pulls taper off the table but raises conundrum for the Fed

Bloomberg News

Economists and market strategists are generally brushing off the surprisingly dismal employment report as weather related, which is giving the financial markets a reason to look elsewhere for areas of concern.

But it is difficult to completely ignore the fact that nonfarm payrolls rose by just 74,000 in December, when the consensus estimate was expecting close to 200,000 new jobs. Meanwhile, the nation's unemployment rate magically fell to 6.7% from 7%, which should be raising some eyebrows.

The December data, the worst monthly jobs report in nearly three years, at the very least takes another round of Fed tapering off the table, according to Paul Zemsky, chief investment officer of multi asset strategies at ING U.S. Investment Management.

“This kind of employment data will put a cap, at least for now, on any further tapering by the Fed, and that should give the market a bit of comfort,” he said.

Perhaps the biggest concern is the way the weak jobs market is driving down the unemployment rate, which could introduce a new riddle for the Federal Reserve to try and solve or at least manage.

As has largely been the case throughout this economic recovery, the unemployment rate has been dropping as the result of more people dropping out of the workforce.

The December reports shows that the percentage of the workforce actively looking for work fell to its lowest level in 36 years by dropping to 62.8% from 63%.

“The unemployment rate is dropping, but unfortunately it's dropping for the wrong reasons,” Mr. Zemsky said. “People are just giving up.”

One of the problems with a theoretical 6.7% unemployment rate is that it is getting dangerously close to the 6.5% rate that the Fed has set as a target range for adjusting interest rates. One would have to assume the Fed understands that the unemployment rate isn't really 6.7%, but if it keeps dropping, it does have the potential to create some awkward moments.

“Unfortunately, we're now at a crossroads in many ways,” said Wilmer Stith, co-manager of the Wilmington Broad Market Bond Fund.

As he sees it, if Congress doesn't act to further extend unemployment benefits the officially reported unemployment rate will continue to fall, potentially putting the Fed in a corner, but by extending unemployment benefits, Congress is just feeding the monster.

“In the Fed's last statement they said they need inflation to be well above the current 1% rate to something in the 2.5% range, but they also said they want the unemployment rate to be in the area of 6.5%,” Mr. Stith said.

With long-term unemployment already accounting for nearly 38% of the unemployed, the trend is something that should not be overlooked or even sugar-coated by a s! hrinking unemployment rate.

“Ultimately, this means the responsibility of paying taxes is falling on fewer and fewer people,” Mr. Stith said. “None of this paints a longer-term rosy picture.”