Disappointing jobs report raises questions over Fed forward guidance

The US unemployment rate dropped from 7% to 6.7% in December as more people dropped out of the labour force but just 74,000 new jobs were added, according to the US Bureau of Labor Statistics – raising questions about the applicability of the Federal Reserve's 6.5% unemployment rate "threshold" as a token of robust economic recovery.

While the Fed has recently downplayed the importance of its 6.5% threshold by emphasising that reaching it will not necessarily trigger a tightening of monetary conditions, today's data is likely to stir debate about the design of the bank's forward guidance strategy, aimed at convincing markets of the bank's resolve in getting the economy back on track.

The seemingly contradictory data – a disappointingly small number of new jobs, but a relatively sharp drop in the unemployment rate – indicate a large number of people exiting the labour market, raising further questions over the suitability of the unemployment rate as a guide for monetary policy.

The resulting confusion will increase market uncertainty over the pace of the Fed's reductions in monthly asset purchases. The central bank began its ‘taper' by cutting purchases by $10 billion to $75 billion last month, citing improved labour market conditions.

At his press conference following that decision, outgoing Fed chairman Ben Bernanke intimated that the Fed was likely to continue reducing purchases at the rate of $10 billion each meeting – but today's jobs report has now sown doubt in analysts' minds.

Alan Ruskin, global head of G-10 FX strategy at Deutsche Bank called the report "one of the most confusing employment reports in quite a while", describing it as "very weak". He added the drop in unemployment had "again been achieved in the main by a slide in the participation rate".

Jan Hatzius, chief economist at Goldman Sachs, said it revealed the unemployment rate as a "relatively poor" indicator of labour market conditions, while David Ader, head of government bond strategy at CRT Capital, said that QE tapering was now "a bit up in the air", adding "they won't accelerate, of course".

Another key factor is the changing composition of the Federal Open Market Committee (FOMC) this year. One new member, Federal Reserve Bank of Minneapolis president Narayana Kocherlakota, said yesterday that he felt the FOMC "could do better with respect to both of its congressionally mandated objectives" – achieving 2% inflation and full employment – "by adopting a more accommodative monetary policy stance".

The Bureau of Labor Statistics figures show that employment rose in retail trade and wholesale trade, but fell in information. The number of unemployed persons overall declined by 490,000 to 10.4 million. The number of long-term unemployed (those jobless for 27 weeks or more), at 3.9 million – 37.7% of the unemployed – showed "little change", according to the report.

Labour force participation declined by 0.2 percentage points to 62.8%, while the employment-population ratio remained unchanged at 58.6%. The labour force participation rate declined by 0.8 percentage points in 2013.