Job Fair April 2012
A job fair in New York. Reuters

The closely watched November jobs report, set for release on Friday, will be the last reading the Federal Reserve will get on the U.S. labor market before policymakers meet this month to decide when to start trimming the $85 billion-per-month bond-buying program.

The Labor Department will release the November employment report on Friday at 8:30 a.m. ET.

Employers probably added 180,000 jobs in November, according to economists polled by Thomson Reuters. That’s somewhat lower than the average of 202,000 job gains recorded over the past three months. The unemployment rate is seen dropping to 7.2 percent, from 7.3 percent in October.

Barclays economists are maintaining their call for a March taper, unless this Friday’s jobs report turns out to be much stronger than expected and the other data also suggest stronger growth.

One reason is that Fed Vice Chair Janet Yellen in her confirmation hearings said the Federal Open Market Committee was looking for gross domestic product growth that was strong enough to suggest continued progress in improving the labor market. Barclays’ tracking estimate for the fourth-quarter GDP growth stands at 1.7 percent, which is unlikely to be strong enough to give the FOMC confidence that the pickup in payroll growth will be sustained.

“With only a limited set of data points likely to affect the growth outlook before the December meeting, we do not think there will be convincing evidence of a pickup in growth by that time,” said Michael Gapen, chief U.S. economist at Barclays.

In addition, economists look for average hourly earnings to rise 0.2 percent and average weekly hours to rise to 34.5, from 34.4 in October.

A Cleaner Report

The federal government shutdown distorted the household survey last month, and economists expect much of this to be reversed in the November report.

In the October household survey, the Bureau of Labor Statistics classified 223,000 furloughed government workers as unemployed on temporary layoff status, up from 19,000 in September, for a net increase of 204,000 on the month.

The Labor Department reported that 84,000 federal workers in October were recorded as employed part time for economic reasons due to a reduction in hours. This was up from 70,000 in September, for a modest net increase of 14,000. However, the total number of workers classified as employed part time for economic reasons rose 178,000 on the month, suggesting that private sector federal contractors or other private sector workers who conduct government-related operations saw their hours reduced.

Furthermore, the Labor Department also indicated that some of the furloughed federal workers may have been misclassified in the October survey. In October, 307,000 federal workers were classified as employed with a job but not at work, 196,000 more than in the September survey.

The Labor Department indicated that they should likely have been classified as unemployed on temporary layoff, but were instead misclassified during the sampling process. As a result, these 196,000 workers were classified as employed and did not contribute to as strong a rise in the October unemployment rate as economists had expected.

In addition to the potential misclassification of furloughed federal workers, the unemployment rate did not rise as economists had expected because of the substantial 0.4 percent decline in labor force participation.

“It seems likely that some of this large downward move in participation is related to the misclassification of government workers, and we look for some of this drop to be reversed in the November report,” Gapen said.

The Fed's Dilemma

The unemployment rate has fallen steadily from a peak of 10.0 percent in late 2009, to 7.3 percent in October. As the government shutdown was probably responsible for the slight uptick in October specifically, there is a good chance that the unemployment rate will drop back to 7.2 percent in November and it is now possible it could end the year at only 7.0 percent.

When the Fed launched the third round of quantitative easing, or QE3, just over a year ago, officials expected the unemployment rate to be between 7.6 percent and 7.9 percent in the final quarter of this year. The rate wasn't expected to get down to 7.0 percent until the final quarter of 2014.

Since the decline in the unemployment rate has been so much bigger than originally expected, it might seem strange that the Fed is still reluctant to begin winding down its quantitative easing.

“The dilemma facing the Fed is that the unemployment rate has been falling not just because employment has been rising, but also because people are leaving the active labor force,” Paul Ashworth of Capital Economics said.

The labor force participation rate, which measures the proportion of the population either working or looking for work during the month, dropped to a 35-year low of 62.8 percent in October.

This has forced Fed officials to revise their thinking radically. By September, when the Fed unexpectedly opted not to slow the pace of its asset purchases, Chairman Ben Bernanke was warning that “the unemployment rate is not necessarily a great measure in all circumstances of the state of the labor market overall" and, consequently, "there is not any magic number that we are shooting for.”

Fed officials are considering whether they should amend their existing forward guidance, which currently pledges to leave the fed funds rate at near zero until the unemployment rate falls to 6.5 percent or lower. Minneapolis Fed President Narayana Kocherlakota has suggested cutting the so-called threshold level to 5.5 percent.

“The push by officials to delay tapering its asset purchases and possibly to lower its unemployment rate threshold suggests that the Fed expects the participation rate to rebound,” Ashworth said, adding that he expects the aging of the population will drive the participation rate even lower over the next five years.

“If we are right, the Fed might eventually find itself in a bind, as real earnings growth begins to pick up while it is still committed to leaving interest rates at near zero,” Ashworth said. “As a result, the Fed would be forced to choose between risking its credibility by raising rates more aggressively than it is currently suggesting or allowing inflation to climb above the 2 percent target.”