The June employment report
July 11 – 15, 2016
The monthly job market report is valued for its timeliness and its ability to drive the outlook for a number of sectors, including manufacturing, construction, and retail sales. Still, the figures are statistical estimates and seasonal adjustment is often difficult. The upside surprise in June followed a downside surprise in May. Such large month-to-month swings are unusual, but they do happen from time to time. Yet, if the weak May number was an anomaly, then so too was the figure for June. Job growth appears to have slowed, but not terribly.
There is a seasonal pattern in jobs. A steep fall in January (marking the end of the holiday shopping season) is followed by strong gains in the spring. Last year, the economy added 4.098 million jobs between January and June. This year, 3.962 million were added over the same period – slower, but not by a lot.
The three-month average reduces a lot of the noise in the monthly payroll figures. Job growth for the first half of the year was slower than in 2015 – the question is why.
There is still a fair amount of noise in quarterly averages of payroll gains. So, some of the first half slowdown could be a fluke. However, more likely, firms have reduced their hiring. The ADP estimate of private-sector payrolls has shown a slower trend in hiring by large firms, which are likely more sensitive to the global outlook. Hiring has remained relatively strong for small and medium-sized firms, although somewhat slower this year. Anecdotally, many businesses report difficulties in hiring qualified workers (that is, those willing to work for what the firm wants to pay). With population growth slowing, the job market will tighten more rapidly than it would otherwise. Long-term unemployment and the percentage of people working involuntarily part-time are still above normal levels, suggesting that there is still a lot of slack in the job market, but they have been trending in the right direction.
The Fed needs to set monetary policy with an eye to where the economy is likely to be 12 months from now. It’s easy to imagine that the job market will be even tighter. Most Fed officials see this as justification for moving to a more neutral policy position. However, wage growth is still relatively moderate, hardly suggesting a “tight” job market. Moreover, the risks to the outlook are weighted to the downside. The problems in the rest of the world, and there are many, from Brexit, to shaky Italian banks, to a major restructuring in China, will have some impact here. However, the flight to safety has pushed long-term interest rates down, which ought to provide further support to the housing sector and should be stimulative for business fixed investment. Still, while the Fed is expected to remain in tightening mode (that is, pondering an increase in short-term interest rates), it is unlikely to act anytime soon.
Economic growth in the U.S. is expected to be moderately strong in the near term – not too fast, not too slow. However, the financial markets are likely to remain battered off and on by ongoing worries about the rest of the world.
Meanwhile, back at the ranch…
July 4 – July 8, 2016
While the Brexit vote and initial reaction (over-reaction?) is behind us, there will be a lengthy and uncertain process of disentanglement from the European Union. Brexit has dominated the market action, but we should be seeing greater interest in the U.S. data. Recent figures suggest a pickup in economic growth in 2Q16. Running contrary to this strength, growth in nonfarm payrolls appeared to slow significantly in the first two months of the quarter. The question is why? This Friday, we should get answers. The July Employment Report will be the key driver for the near-term economic outlook.
Recall that nonfarm payrolls rose far less than expected in May (private-sector jobs up 25,000), while figures for March and April were revised lower. A strike at Verizon subtracted about 35,000, and while those workers will return in the June payroll total, payroll growth was still lower than expected. Mild weather may have pulled forward seasonal job gains. The soft May figure could represent statistical noise (the monthly change in payrolls is reported accurate to ±115,000). There could be issues with the seasonal adjustment (perhaps an earlier end to the school year). Amid uncertainty about Brexit and the presidential election, firms may have slowed their hiring, or perhaps firms have had a more difficult time finding qualified workers as the job market has tightened.
Growth in payrolls was already expected to slow this year as the unemployment rate declined. We only need about 100,000 jobs per month to be consistent with the growth in the working-age population and much of the slack generated from the financial crisis has been taken up. Still, wage growth, while higher than in 2013 and 2014 (+2.0%), has remained relatively lackluster (+2.5% y/y). Anecdotally, firms report difficulty in finding qualified workers (that is, workers willing to work for what the firm wants to pay). With minimum wages moving higher, wage growth should pick up over time.
The early Easter shifted some spending from March to April. The May figures were moderately strong, suggesting a robust pace in second quarter spending. Granted, this follows a soft first quarter, but averaging the two quarters, inflation-adjusted spending growth is likely to have been close to a 3% annual rate in the first half of the year. Take that with a grain of salt. The upcoming annual benchmark revisions could alter that view.
The one area of clear weakness in the economy has been in capital investment. Much of this weakness has been concentrated in energy exploration, which won’t fall forever (hence, will no longer be a drag on overall growth). Yet, ex-energy, business fixed investment has been relatively soft, consistent with a soft global economy and a slow patch in manufacturing, not an outright recession.
Capital spending rises and falls over the business cycle, but for the economy as a whole, the consumer drives the bus. Better wage growth ought to offset a slower trend in job growth and keep consumer spending on a moderately strong path.
Anarchy in the U.K. / I’m so bored with the U.S.A.
June 27 – July 1, 2016
Caught leaning the wrong way, the financial markets were hit hard by the outcome of the U.K.’s referendum on EU membership. However, the decision to leave the European Union is not a Lehman-type event. A full-blown panic is unlikely and we should see the U.S. market settle down early this week. The outlook for the U.K. economy is not good. Meanwhile, back at home, investors will look to the calendar and collectively yawn. While a number of data releases have market-moving potential, none is going to alter the underlying picture of the economy – that is, until the June employment report arrives on July 8.
What were they thinking? The majority of economic studies on the EU exit impact pointed to severe consequences for the U.K. economy. Some voters recognized this and still wanted to leave. The desire for self-rule was a motivating force. As in the U.S., the economic recovery in the U.K. had passed many individuals by. The “elites” in London were seen doing well, but the “common people” struggled simply to maintain their living standards. Throughout the campaign, many felt that they were being talked down to by the powers that be. Much of the push for “leave” came from anti-immigrant feelings. The “leave” campaign misled on the impact of immigrants, suggesting that they were a drain on the National Health Service. UKIP leader and Brexit supporter Nigel Farage said that the “leave” campaign was “scaremongering” and described some of the advertisements (not his, of course) as “a mistake.”
There were significant differences in votes by educational attainment, with those with degrees most likely to vote “remain” and those with less education more likely to choose “leave.” Scotland voted strongly for “remain.” Scottish First Minister Nicola Sturgeon said that a second referendum for independence (from the U.K.) was “highly likely.” Northern Ireland may also move to leave the U.K. and rejoin the EU.
The key factor here is uncertainty. Prime Minister David Cameron has resigned (effective October), and his successor will face a lengthy negotiation (two years) with the EU on exit terms. This isn’t going to be pretty. It’s effectively a divorce with 27 wives all wanting some sort of alimony. Uncertainty is the enemy of business fixed investment. Even prior to the vote, there was evidence of firms pulling back on capital spending plans. Residential and commercial real estate transactions were being postponed. Consumers delayed big-ticket purchases. Economic growth in the U.K. will take a hit and there is a good chance of an outright recession.
The Bank of England has some room to cut rates, but the proper policy response isn’t clear. The weaker pound will boost inflation. The central bank will have to decide which problem, slower growth or higher inflation, is the greater.
The direct impact on the U.S. economy may be small. The U.K. accounts for less than 4% of U.S. exports and less than 3% of U.S. imports. Still, many U.S. firms do business in the U.K., so slower U.K. growth isn’t going to help (especially on top of sluggish global growth in general).
The referendum result sent global equity markets reeling. The pound fell sharply (to a 30-year low). A flight to safety pushed bond yields down. The 10-year Treasury note yield sank from 1.74% to 1.41% (briefly), before bouncing about halfway back. This seemed to be largely a knee-jerk reaction to a surprise, rather than an outright panic. Stock markets, bond yields, and the pound rose off their lows. The U.S. markets have had plenty at home to deal with in recent weeks, including three appearances by Fed Chair Yellen and a host of economic data reports. However, all of that was dominated by Brexit concerns.
The U.S. economic outlook should not change much following the Brexit vote. The U.S. economy was already not getting much help from the rest of the world, but domestic demand should remain moderately strong. Housing is in good shape. Consumer fundamentals remain sound, although low gasoline prices will provide less support for spending over time. Business fixed investment has been weak, but much of that has been tied to the contraction in energy exploration. Ex-energy, capital spending appears soft, but this is more consistent with a slow patch than an outright recession. Still, as Fed Chair Yellen noted in her Congressional testimony, “considerable uncertainty in the economic outlook remains.”
The pace of job growth is a key concern for the Fed. Job growth slowed into 2Q16. The May payroll figure was restrained by the strike at Verizon, but these workers will come back in June. Accounting for the strike, job growth was still lower than in the early part of the year, but it’s unclear why. Statistical noise may have been a factor. Firms may have reduced hiring in the face of uncertainty. Firms may have had a tougher time finding qualified workers (willing to work for what the firm is going to pay). The June employment report, due July 8, should help to answer many of these questions. Between now and then, the economic calendar is not very eventful.
With the Brexit vote out of the way, attention may return to previous worries, such as China and Greece. Financial market volatility may die down somewhat, but it’s not going to go away.
The bigger concerns are longer term in nature. In her testimony, Fed Chair Yellen said that “although I am optimistic about the longer-run prospects for the U.S. economy, we cannot rule out the possibility expressed by some prominent economists that the slow productivity growth seen in recent years will continue into the future.” Quoting one famous philosopher, “it just goes to show ya, it’s always somethin’.”
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