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Fed policy makers face tough challenge in jobs data

A police officer guards the Federal Reserve building on September 10, 2011 in Washington, DC
A police officer guards the Federal Reserve building on September 10, 2011 in Washington, DC. Federal Reserve policy makers face a tough challenge as they opened a two-day meeting to weigh cuts to their stimulus program Tuesday.

Federal Reserve policy makers face a tough challenge as they opened a two-day meeting to weigh cuts to their stimulus program Tuesday.

The launch of the "taper" -- reining in its $85 billion a month bond-buying program -- has been expected since May, when Fed chairman Ben Bernanke said it was likely as long as the economy continues to grow steadily.

The Federal Open Market Committee, which Bernanke leads, went as far as to predict the whole "quantitative easing" program would be wound up by mid-2014.

At that time, the economy would be fairly strong and the jobless rate near 6.5 percent. So the Fed could start "normalizing" monetary policy -- that is, begin raising interest rates off their near-zero levels, finally putting the 2008-09 Great Recession behind.

But economists say the details in economic data and a challenging policy environment should tell the FOMC to keep the stimulus in place, or not go further than a token stimulus cut.

For one, indicators suggest the economy may have slowed since the second quarter's 2.5 percent pace, and that part of the cause could be cuts in government spending.

In addition, more spending cuts are scheduled. And the White House and Congress are on the edge of a tough fight over the coming year's budget and raising the debt ceiling that could generate more uncertainty in the economy.

"If you think about the balance of risks, this is a bad time to be doing anything that looks like a tightening of monetary policy," said economist Paul Krugman in the New York Times.

The expectation of a policy shift has already sent market interest rates higher, and the yield on the benchmark 10-year Treasury bond has nearly doubled in four months, from 1.6 percent to 3.0 percent.

That has been perhaps more than the FOMC expected in communicating its intentions. It has pushed up US loan rates, with data suggesting that has already slowed consumer spending and home buying -- potentially stifling the recovery in the broader housing sector.

That was borne out in fresh data Tuesday from the National Association of Home Builders, whose builder confidence index held steady in September after months of gains.

"While builder confidence is holding at the highest level in nearly eight years, many are reporting some hesitancy on the part of buyers due to the sharp increase in interest rates," said NAHB chairman Rick Judson.

In addition, jobs data announced on September 6 proved a disappointment. The economy generated a middling 169,000 net new jobs in August, and the data for the previous two months was revised sharply lower.

Nevertheless, the unemployment rate fell again, to 7.3 percent.

But that was more because of a rise in the number of people dropping out of the jobs market altogether. The participation rate in the work force fell to 63.2 percent, the lowest level since 1978.

Even so, it put the jobless rate on track to fall to 7 percent by year-end and, by next year, close to the 6.5 percent level that the FOMC has already set as its threshold for normalization: taking monetary policy off its five-year crisis footing by raising interest rates.

Critics say the Fed needs to focus not on the unemployment rate but the number of labor market dropouts, which points to continued hardship in households.

The FOMC has already essentially committed itself on tapering its stimulus, suggested Shushanik Papanyan at BBVA Research.

But, with the mixed picture for the economy, the first taper will be small, and the Fed will stress that it continues to support the economy, he said.

"The Fed will sneak in a $5 billion Treasury purchase decrease," he said.

But "Fed policy communication will emphasize continuance of the asset purchases rather than focusing on the taper."

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