09/11/2012 04:31 pm ET Updated Nov 11, 2012

Paltry Payroll Report Strengthens Argument for QE3

Payroll employment rose by a tepid 96,000 jobs in August, after being revised down significantly for the last two months. Gains were broad-based but muted. Tourism (hotels, amusement parks) was one of the primary beneficiaries as Americans chose shorter drives near home instead of leaving the country for island, resort vacations. Construction was weak, but residential, specialty-trade contractors did show much stronger job gains. This reflects a pickup in investors in the housing market and renewed remodeling activity.

The biggest losses were experienced in the public and manufacturing sectors. Teachers were laid off at the state and local levels as pink slips given at the end of the 2011-12 school year were executed. We keep waiting for state and local government budgets to firm, but it just isn't happening. The slowdown in manufacturing can be attributed to a combination of factors: The auto sector had some giveback in jobs after postponing July plant closures; growth abroad continued to weaken, particularly in Europe and China; and, the fiscal cliff (more than $600 billion in expiring tax cuts and mandated spending cuts slated for Jan.1, 2013) has prompted several manufacturers to delay hiring and investment projects that were already in the pipeline. Indeed, some large companies have begun to cite the fiscal cliff as a risk in their guidance to financial markets on profits.

Separately, the unemployment rate fell from 8.3 percent (8.25 percent) to 8.1 percent between July and August. That drop is not statistically significant. Moreover, the decline occurred for all the wrong reasons: The labor force declined, while the labor force participation rate dipped to its lowest level since 1979. Some of the drop in participation can be attributed to a rise in early retirees. We are also seeing students stay in school longer because they can't find a job and don't want to start the clock ticking on their student loans; students must start servicing their student loan debt within six months of graduating, which is a daunting prospect when you don't think you can get a job.

Bottom Line: Today's subdued employment report, coupled with significant downward revisions to the last two months, will tip the scales in favor of easing sooner, rather than later, for the Federal Reserve. Look for additional quantitative easing, mostly in the form of mortgage-backed security purchases, at next week's meeting. Might as well support a market that is already healing, than try to lower the already-low Treasury bond yields.