By Steven K. Beckner

(MNI) – Disappointing data on employment and manufacturing activity
Friday heightened speculation that the Federal Reserve will take
additional steps to stimulate the economy at its June 19-20 Federal Open
Market Committee meeting.

But there is uncertainty about what form further monetary stimulus
would take and about what good it would do for an economy still
struggling to achieve enough economic growth to persistently reduce
unemployment.

Fed policymakers themselves are divided on that score as they
confront a situation in which various headwinds and downside risks
continue to impede economic growth, investment and hiring despite some
of the lowest interest rates in American industry.

For the third consecutive month, the Labor Department reported weak
job growth, and downward revisions darkened the labor market picture
even further.

The unemployment rate ticked back up a tenth in May to 8.2%. Hours
worked declined, both overall and in manufacturing. Average hourly
earnings rose just 0.1%. And, most notably, non-farm payrolls, which had
been expected to rebound by 150,000, instead rose a meager 69,000.
What’s more, prior months’ payrolls were revised down by 49,000.

After averaging more than 252,000 in the December through the
February period, payroll gains have averaged just 96,000 over the past
three months. That is under the 100,000 level which Fed Chairman Ben
Bernanke has said is needed in the current environment of low labor
force participation to keep unemployment stable and far below most
estimates of the amount needed to actually reduce unemployment.

Bernanke, among others, has allowed for the possibility that
earlier, bigger job gains reflected warm winter weather and/or a
“reversal” of the heavy lay-offs during the recession and that
subsequent weaker numbers are to some extent a “payback.” But he also
has said the economy would likely need to grow faster to continue
progress on employment.

Instead, the data seem to be pointing in the opposite direction.
While there is still some doubt about how persistent weaker job gains
are and uncertainty about weather effects, there is growing suspicion
that the economy has entered a slowdown which could be exacerbated by
shocks from abroad.

The Commerce Department revised down its estimate of first quarter
growth from 2.2% to 1.9% — well below the economy’s supposed
“potential” growth rate. And second-quarter data have not pointed to
much improvement.

As the Labor Department was releasing the dismal job numbers, the
Institute for Supply Management’s survey of corporate purchasing
managers in the manufacturing sector showed a surprising May slowdown in
manufacturing activity. The ISM’s index fell more than expected from
54.8 to 53.5 despite an increase in new orders.

Meanwhile, for April, the Commerce Department reported a less-than
expected 0.3% rise in construction spending and a halving of personal
income growth to 0.2%. Personal consumption expenditures grew a slightly
faster but still modest 0.3%.

The PCE price indices which the Fed watches most closely confirmed
further disinflation, being flat overall and up 0.1% excluding food and
energy. That left both indices below the Fed’s 2% target on a
year-over-year basis — presumably giving the FOMC further latitude to
ease monetary policy if it chooses.

One Fed official who thinks it must do so without delay is Boston
Federal Reserve Bank President Eric Rosengren, who told MNI ahead of
this morning’s data that he believes more stimulus is needed now and
that “more aggressive” action may be needed by the time the FOMC meets
if there is further deterioration in the U.S. economic outlook and a
worsening of downside risks from Europe.

Rosengren, who will be an FOMC voter next year, acknowledged he has
become more inclined to ease policy since March because “since that time
the overall hue of the data has been consistent with growth only at
potential and not much improvement in the labor markets, and that’s
become clearer as we’ve gotten end of March, April and May data.”

Rosengren said he has also become more ready to ease because of
heightened downside risks and uncertainties from Europe, which he said
“have an impact on consumer behavior” and on business investment. “That
kind of uncertainty does have costs that can get imbedded.”

Rosengren, among others, has said the Fed could initially extend
“Operation Twist” and/or change its communication to hold interest rates
low. And he said he would favor something “more aggressive,” such as a
third round of large-scale asset purchases or “quantitative easing,” if
things worsen.

But as MNI reported earlier in the week, further easing is “not a
foregone conclusion.” There is some hesitancy among Fed officials to move
based on an assessment of the costs and benefits.

With rates already very low (the 10-year yield went as low as
1.439% in wake of the jobs report), the benefits of additional easing
might be small relative to the costs, which include complicating the
Fed’s eventual exit task and possibly unhinging longer term inflation
expectations.

A further intensification of the European debt crisis, together
with more gloomy economic data could change the cost-benefit analysis,
however, and increase the odds of some kind of Fed action.

As New York Fed President William Dudley said Wednesday, “If the
economy were to slow so that we were no longer making material progress
toward full employment, the downside risks to growth were to increase
sharply, or if deflation risks were to climb materially, then the
benefits of further accommodation would increase in my estimation and
this could tilt the balance toward additional easing.”

“Under such circumstances, further balance sheet action might be
called for,” Dudley said. “We could choose between further extension of
the duration of the Federal Reserve’s existing Treasury portfolio and
another large-scale asset purchase program of Treasuries or agency
mortgage-backed securities.”

Top Fed watchers were not prepared to conclude Friday that the
table has been set for more easing. A common refrain was that trying to
push already low rates even lower might avail the Fed little.

Joseph Lavorgna, chief U.S. economist for Deutsche Bank AG,
described the latest economic data as “lousy,” but noted that the
economy went through similar downswings the past two springs.

Still, Lavornga said there is cause for concern about “financial
market interconnections” with Europe as well as uncertainties ranging
from the Greek election to the U.S. Supreme Court decision on Obamacare.
He said he will be watching jobless claims, consumer confidence and
energy prices very closely in coming weeks.

Lavorgna was skeptical about whether the FOMC will launch QE3.
“Given where rates are, we already have QE3, QE3 1/2 and QE4,” he
remarked. “I’m not sure what the benefits of further easing are.”

The cost of borrowing is “not the issue,” given reluctance to lend
and borrow, he continued. “I’m not sure what decreasing rates by 25 to
50 basis points does.”

If anything, Lavorgna said Fed action could backfire by “sending a
message that things are still pretty bad.” He suggested the Fed might
better send a signal that “actions need to be taken by other
authorities.”

Lavorgna was also dubious about extending Operation Twist, which
unlike QE3 would not expand the Fed’s balance sheet. “I don’t’ see the
benefit of it other than the appearance of doing something.” Lengthening
the expected period of a zero federal funds rate to 2015 might be
better, he suggested.

Diane Swonk, chief economist for Mesirow Financial, said the latest
data cannot be explained away by reference to weather but show “a
fundamental weakness in the U.S. economy” that has been worsened by
foreign developments.

“The United States is not an island,” she said. “Europe and China
matter … . Europe and China are weakening, and we’re feeling it.”

She said delayed fiscal decisions on both sides of the Atlantic are
“adding to the uncertainty” and to “hesitations to hire.”

But Swonk was also dubious about whether the Fed should inject more
stimulus. She said “the probability of QE3 has gone up, not just because
of these numbers, but because of Europe.”

But she said the FOMC will likely stay on hold June 20 “barring a
major blow-up in Europe, which is highly possible.” In that event,
whenever it happens, she said the Fed “will be in reaction mode.”
Meanwhile, “they’re watching Europe very closely.”

-more- (1 of 2)

** MNI **

[TOPICS: MAUDS$,M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]