Zervos: Do We Have Slack or Slackers?

David Zervos
Managing Director and Chief Market Strategist, Jefferies & Co. Inc.
David Zervos is managing director and chief market strategist at Jefferies & Co. Inc. He is known for his provocative market strategy and views. Zervos joined Jefferies in 2010 after spending 2009 as a visiting advisor in the Division of Monetary Affairs at the Board of Governors of the Federal Reserve System in Washington, D.C. Prior to the Fed, he held a variety of research, sales and trading positions in the private sector, most recently managing global macro portfolios for Brevan Howard and UBS O'Connor. He began his career as an economist at the Federal Reserve Board in the early 1990s. He received a B.S. from Washington University and an M.A. and Ph.D. in economics from the University of Rochester.

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Do We Have Slack or Slackers?

The December payroll report does NOT suggest that labor market momentum is increasing. The modest 78k increase in payrolls, plus the 34k in positive revisions barely gets us half of what was expected. But the most concerning part of the report comes from the household survey where we saw another 347,000 people leave the labor force. And it was not just more retirees, or more youngsters going to college. The largest acceleration downward in the participation rate came from the 45-54 year old cohort - that rate fell 0.5 percent, from 79.6 to 79.1.

In the early part of the crisis, the most important driver of a lower participation rate came from the younger cohorts. But these 16-19 and 20-24 year old groups have been stable in recent quarters, albeit at much lower levels. The "trouble" now is manifesting itself with the seasoned veterans!

However, as always with participation rates, we have to be careful with interpretations. The current 45-54 year participation rate of 79.1 percent is the same as it was in 1988. Were we all complaining in 1988 about participation rates and excess slack? Not really. And while the overall participation rate is back to 1978 levels, why is that such a bad thing? More kids are heading for higher education. And the baby boom demographics are working through the labor force dynamics as expected. Also, more two earner households are choosing to have a stay at home parent. Who is to say what the "right" participation rate is, or what the "right" family structure is.

But all of that aside, we still have a large number of 25-54 year old able bodied workers who have left the labor force since the crisis. The question is how many will come back if economic prospects improve? Do we have slack or slackers, that is the question.

The FOMC has told us they see slack, not slackers. Its why the SEP forecast for the end of 2016 has a 3 percent growth rate, a 2 percent PCE inflation rate, a 5.5 percent unemployment rate and 1.75 funds rate. They believe that very low risk free real rates will be appropriate even with "equilibrium" growth, "equilibrium" inflation and unemployment at or near the NAIRU. Why do they believe this? Because they think that by running policy "hot", even at equilibrium, they can bring these disaffected workers back into the labor market. That is the plan!!

Only time will tell if they are right. And honestly no one really knows. What we do know is the FOMC is going to try to coax the slack (and slackers) back into the real world. That's what they have explicitly told us they are going to do. And to that end today's report will be embraced by doves who see accommodation appropriate, and a slow and steady taper as the path forward. So with the Fed on the gas pedal, and doves in the drivers seat, there is no reason why risk assets won't continue to perform well. The only material volatility in the market will center on back month euro dollar futures - they could move substantially in either direction on small changes in data and perceptions (as they have done in the first couple weeks of 2014). I'm happy to have no position these anymore - the risk/reward looks uninteresting. The current hedge for a long risk asset position is just the Fed reaction function - that's it!. They are committed to the reflation trade and they are committed to exorcising slack from the labor markets. There is nothing in this employment report that should be interpreted negatively for Spoos and Q's. BTD!!! Good luck trading.
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'Spoo' - A slang term for an S&P 500 contract that trades on the Chicago Mercantile Exchange (CME).
'Q's' - A slang term for the NASDAQ 100. 'QQQQ' was the previous ticker symbol for the Nasdaq 100 Trust, an ETF that trades on the Nasdaq. It changed its symbol to QQQ in early 2011.