The Fed still appears to be planning to start winding down its asset purchases. The real jobs numbers: 2014, 2016

NEW YORK - Welcome to the good-news-could-be-bad-news economy.

Friday’s Labor Department report showing a better-than-expected gain of 195,000 jobs in June was a heartening sign for many that the economic recovery continues to move ahead at a modest pace. But it could ultimately turn out to be bad news, especially for Democrats, because it means that the Federal Reserve might start winding down its extraordinary efforts to boost the economy later this year.


And if the Fed takes the juice away too soon it could tank the stock market, crush housing prices, snuff out the four-year-old economic recovery, and make life exceedingly difficult for any Democrat who hopes to run in 2016 for what will essentially be President Barack Obama’s third-term.

( Also on POLITICO: Economy adds 195K jobs in June)

“This jobs report is a data-point that will get people wondering if the Fed will really start pulling back as soon as September, as many people are expecting,” said Nigel Gault co-chief economist at the Parthenon Group. “And it certainly raises the stakes for the next for the next three jobs reports.”

Stocks initially rose on the jobs news. But the yield on the 10-year Treasury note, which is the benchmark for everything from home loans to credit cards, quickly spiked over 2.7 percent, the highest level since 2011, indicating investors fear the good hiring number will make the Fed move faster.

Fed moves and pronouncements from central bank chairman Ben Bernanke may seem like the province of quick trading market jockeys and green eyeshade economists. And they are. But they will also have an enormous impact on the economy and political landscape for the 2014 midterms and 2016 general election.

( PHOTOS: Senators up for election in 2014)

To an unprecedented extent in recent years, the Fed has become the focal of point of U.S. economic policy. The central bank under Bernanke filled in for a polarized political process in Washington whose main recent contributions include a downgrade of the nation’s credit rating in 2011 and a crudely designed set of spending cuts this year.

To fill the breach, Bernanke has kept the Fed’s target for short-term interest rates at effectively zero and exploded the bank’s balance sheet by buying up huge amounts of Treasury bonds and mortgage debt. The effect has been to boost home and auto spending, which in turn is driving much of the economic recovery, such as it is. The traditional drivers of stronger long-term growth, including business investment and higher wages, are largely absent. Friday’s jobs report showed wages rising 10 cents to $24.01. Over the year, hourly earnings are up 2.2 percent, not the kind of growth likely to survive higher interest rates.

And the jobs being created are not the kind of high-wage positions that tend to drive a robust economy. The leisure, hospitality and retail industries added 112,000 of all the jobs created in June. Professional and business services added just 53,000. The average workweek was unchanged at 34.5 hours, suggesting employers do not see much need to try and boost production. The number of workers who want full-time jobs but were only employed part time surged by 322,000 to 8.2 million, a figure some attributed to employers declining hire workers full-time in order to avoid the mandate to provide coverage under President Barack Obama’s health reform law. The unemployment rate was unchanged at 7.6 percent.

Despite all this, the Fed still appears to be planning to start winding down its asset purchases as soon as September, a precursor to eventually increasing interest rates, on the theory that economy will soon be able to stand on its own.

If the Fed gets it wrong and pulls the plug too quickly, economists say it could send interest rates soaring and tip the economy back into recession. That in turn could rob Democrats of one of the advantages they have in the 2014 midterms and make the environment much less hospitable to Hillary Clinton or any other Democrat who hopes to succeed Obama in 2016.

“We already saw the tremendous volatility in the stock and bond market last month when there was just a little verbal evidence from Bernanke that the Fed might be moving sooner rather than later,” said Bill Galston, a Brookings Institution scholar and former Clinton administration official. “The hope is that the Fed gets it just right and unwinds its portfolio perfectly in synch with the economic recovery. But the Fed could also guess wrong and that bad guess could be the frame for the entire 2016 campaign.”

Democrats are certainly aware that, to a large extent, their hopes to overcome the traditional GOP advantage in 2014—the sixth year of an incumbent president’s term strongly favors the opposition party—rest on a strengthening economy. And they know their electoral college and demographic advantages in 2016 may not be enough to overcome an economy turning sour yet again.

“There is no doubt that the midterm for the incumbent party is historically very difficult and the one variable this time around could be the strengthening economy and the Fed could be a wild card there,” said Ben LaBolt, who served as chief spokesman for Obama’s re-election campaign and is a co-founder The Incite Agency. “But as cautionary note for Republicans, even when the economy was very much up in the air for many families in 2012 their arguments didn’t sell.”

No one is suggesting it is a certainty that the Fed will screw things up and derail the economy.

And the negative market reaction to Bernanke’s recent comments—including a scary spike in interest rates—led other Fed governors to issue soothing statements that the Fed won’t move too fast to take away stimulus and that actual rate hikes remain at least a year away.

But the central bank is headed into completely uncharted terrain, having never engaged in the kind of bond-buying it conducted following the financial crisis and subsequent recession. Add to that the fact that Bernanke is almost certainly departing early next year, leaving the wind-down to an untested successor, and the ingredients are there for potential disaster.

“You could see the Fed trigger an interest rate shock and a complete reversal in an economy where things are already very fragile,” said Bob Eisenbeis, chief monetary economist at Cumberland Advisors and a former official at the Federal Reserve Bank of Atlanta. “If that rate shock happened, consumer confidence would drop way off, businesses would stop investing and the housing market would come to a stop.”

But for every economist who worries the Fed could single-handedly wreck the economy, there are others who insist concerns that the central bank will move too soon are overblown.

These people say recent wild markets swings reflect a gross overreaction driven by short-term traders looking to cash in on people’s fears of the Fed.

And they say there is little chance the economy meets the current Fed forecast of 2.3 percent to 2.6 percent growth for 2013, especially since the economy grew at just 1.8 percent in the second quarter and federal budget cuts will continue to drag for the rest of the year. This means the Fed could easily cancel its plans to pull back until well into next year, if not later.

“They are not going to take away the punch bowl because not everyone is drunk yet,” said Catherine Mann, a Brandeis University professor and former Federal Reserve and White House official. “Some people in the financial markets may be drunk but they still aren’t sharing.”

The timing itself raises another critical political question.

If the Fed decides now is too soon to start pulling away stimulus and hiking rates, it may instead have to do so in 2015 and 2016, just as the presidential campaign is getting into full swing. No Democratic presidential nominee will want to see the central bank trying to slow things down at that point.

“You could argue that if the Fed is going to move, it’s better for Democrats they do it now rather than later,” said Galston of the Brookings Institution. “If interest rates are going to go up, you’d probably rather have them going up before the midterms than three and half years into Obama’s term when you are hoping to replace him.”