U.S. Economic Snapshot

By Thomas Cooley and Peter Rupert

Today’s release of the employment situation shows a modest increase in employment of 142,000. Moreover, employment over the past two months was revised down by a total of 59,000 (22,000 for July and 37,000 for August). While the mining and logging sector (oil) continued to shed jobs, manufacturing employment was down for the second month in a row; falling 9,000 in September after falling by 18,000 in August. Although the housing sector has shown some growth, construction employment is still lagging. Average weekly hours also fell back to 34.5.

The household survey also had a weak flavor to it. The unemployment rate stayed at 5.1%, but the labor force fell by 350,000. The employment to population ratio also fell to 59.2.

Last week, the third “estimate” of real GDP for the 2nd quarter of 2015 shows  that output of final goods and services grew by 3.9% at an annual rate compared to 3.7% from the 2nd estimate. There was no change in the final estimate of 1st quarter GDP, remaining at 0.6%.  Personal consumption expenditures (PCE) was the largest contributor, providing 2.42 percentage points of the 3.9% gain.

Chairperson Yellen’s remarks on September 24 mentions again that they could (expect to?) raise rates by the end of the year:

Most FOMC participants, including myself, currently anticipate that achieving these conditions will likely entail an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening thereafter. But if the economy surprises us, our judgments about appropriate monetary policy will change.

The last sentence in the Yellen quote once again provides an out for the Fed not to do anything. It is the nature of the beast that quarterly or monthly outcomes can be much different from the trend without signaling a change in direction. That is, if in the next employment report there is a slight uptick in the unemployment rate, or an employment change of say only 100k workers, will that dissuade members of the committee? There is (almost) always something in a given report, GDP or employment, that can be read as surprising. Perhaps non-residential investment is particularly low, for example. Here are the numbers for the annualized percentage change in non-residential structures over the past six quarters, i.e., starting in 2014Q1: 19.1%, -0.2%, -1.9%, 4.3%, -7.4%, 6.2%. And this for equipment over the same time period: 3.5%, 6.5%, 16.4%, -4.9%, 2.3%, 0.3%.

The bigger question is whether the economy is in a sustained recovery or have we hit a rocky spot giving the Fed further pause? That said, a return to normal monetary policy that begins to eliminate some of the distortions caused by several years of zero interest rates would seem to be beneficial and it is surprising that the FOMC did not see it that way.

by Peter Rupert

The moment of truth concerning liftoff is upon us as the FOMC makes their decision and delivers their verdict tomorrow. With the release of the latest Job Openings and Labor Turnover Survey (JOLTS) and the previous employment report, it appears the labor market is firing on many, if not all, cylinders. The JOLTS data reveal both the highest level (about 5.7 million vacancies) and rate (3.9%) of job openings since the series began in December of 2000.

The unemployment rate is also quite low and the Beveridge Curve (a plot of vacancies vs. unemployment) is now looking much healthier after its typical counter-clockwise journey. Many of the previous statements from the meetings suggested that there was still some slack in the labor market, but it was dissipating. With vacancies as high as ever it appears that businesses are in hiring mode big time…but, inflation is not in sight.

So, the question is: When is the right time? Financial markets are volatile for sure; however, to what extent has Fed policy fed into the volatility? The rest of the world has its problems, but many areas will continue to be problematic for some time to come, see our commentary here.

If the FOMC does not raise rates today, here is what they will likely say: “While labor markets appear to have reduced slack, there is little evidence of inflation. The rest of the world is still in turmoil.” And if they do raise rates, “Labor markets have continued to recover and are now near levels thought to be in the target range. While global markets are still somewhat fragile, the evidence in the US suggests that the current stance of policy is not in line with normal policy.”

by Tom Cooley and Peter Rupert

The Bureau of Labor Statistics establishment survey for August revealed a somewhat expected, yet somewhat disappointing, 173,000 employment increase. Upward revisions totaling 44,000 over the past couple of months took some of the edge off of the disappointment. Private employment posted only a 140,000 gain, however, and government continued to climb, up 33,000. Goods producing declined by 24,000, with manufacturing down 17,000 and mining and logging down 10,000. Given the tendency for the August numbers to be revised upwards this report is in keeping with previous months and is not likely a sign of weakness in the economy.

Hours and Wages:

The average workweek ticked up to 34.6 after three consecutive months at 34.5. Average hourly earnings were also up slightly.

Participation:

From the household survey, the number of unemployed fell by 237,000; however, the labor force was also down, 41,000, leading to a decline in the unemployment rate to 5.1% and no change in the labor force participation rate at 62.6. This is really the major conundrum for the U.S. economy. Labor force participation is at a forty year low. The employment to population ratio has picked up slightly but not anywhere near enough to reverse the precipitous drop during the Great Recession.  The low participation rates suggest there are many workers who have been effectively disenfranchised by the Great Recession which continues to cast its long shadow over the economy.  But these are now structural issues not cyclical ones.

The number of people unemployed less than 5 weeks fell by 393,000 while the number unemployed 27 weeks or more rose 7,000; again showing that the issues seem more structural than cyclical.

by Thomas Cooley and Peter Rupert

The past week has been a wild and crazy ride, capped by a strong GDP report, boosting Q2 growth from the advance estimate of 2.3% to 3.7%. This morning, the personal income release reveals personal income growth of 0.4% for July, the same growth rate as the previous three months. The week began with a Dow drop of about a 1000 points during the morning, but closed down “only” 588 points (-3.57%)…followed by -1.29% on Tuesday, +3.95% on Wednesday, +2.27% on Thursday. That turmoil was puzzling given that most observers saw the U.S. economy as fundamentally strong even before the latest update of Q2, with low unemployment and steady growth in real output.

That the economy has grown steadily, albeit slower than during other recoveries, has given monetary policy makers the opportunity to begin to normalize operations. However, given the length of the recovery, are some now worried about another possible dip…as seen in the 1973 and 2001 cycles below?

The fundamentals of this recovery are strong as well. Consumer spending growth was up 3.1% and has been strong for the past year.

Investment, particularly intellectual property investment was strong.

 

 

 

What Next for The Fed?

The market turmoil of last week led many, including William Dudley , President of the New York Fed, to call for caution in normalizing monetary policy and beginning “liftof”as many expected them to do at the September meeting.  Why the turmoil in markets should cause them be cautious is a puzzling question because it can be argued with some credibility that the state of financial markets has been significantly distorted by the Fed’ policy of the last seven years.  It is even more bizarre to see former Treasury Secretary Larry Summers calling for more asset purchases by the Fed. The fact of the matter is that the U.S. economy is looking extremely normal with low unemployment, steady job growth, and decent growth in real GDP in spite of significant headwinds from the rest of the world and a strong dollar.  If now is not the time to return to normal monetary policy, when will be?

By Tom Cooley and Peter Rupert

The employment report released today by the BLS was in line with expectations and so no surprises anywhere to speak of.

Establishment Survey

The establishment survey reveals total nonfarm payroll employment increased by 215,000 in July; both May (+6k) and June (+8k) were revised up slightly from the previous estimate, although the average monthly gain for the previous 12 months is 246k. While employment growth has remained steady, though slightly below its 12 month average, today’s report appears to keep the Fed on track for liftoff…most likely in September.

Average weekly hours ticked back up to 34.6 after four straight months at 34.5. Average hourly earnings for all employees on private nonfarm payrolls rose by 5 cents to $24.99, up 2% over the past 12 months.

Household Survey

The household survey conveys a slightly weaker picture of the labor market. Household employment grew only 101k. Moreover, the increase over the past five or six months has been much lower than that for the establishment survey. The unemployment rate was virtually unchanged as was the employment to population ratio and the labor force participation rate.

The Fed

Overall, then, it appears that given the steady performance of the labor market and the commentary from various Fed folks: Atlanta Fed President Lockhart, “It will take a significant deterioration in the economic picture for me to be disinclined to move ahead.” And St. Louis Fed President Bullard, “We are in good shape,” to raise rates in September, leads one to believe a rate hike is quite likely. But here is where one should give pause.

What is the rush to start “liftoff” when there is so little evidence of inflation? One argument might be that keeping interest rates so low creates distortions, but those distortions have been in place now for several years and might be described as the new normal. The Fed of yore would have waited to see some signs of inflation. While many have latched on to the Summers’ quote about not raising rates until you see the whites of its eyes, it is not a new concept nor a new phrase. Alan Blinder said this in a Minneapolis Fed meeting back in 1995. His point then was that it takes time for monetary policy to work,( long and variable lags):

So what is a poor central banker to do? When you look at this set of difficulties—forecasts are not very good, theories and statistical evidence are much in dispute—it is tempting to say: Why don’t we just wait and see what happens? If inflation starts rising, hit the economy with higher interest rates. If unemployment starts rising, do the reverse. I call this the Bunker Hill strategy: Wait until you see the whites of their eyes and then fire. Why don’t we do that?

The answer is very simple: The Bunker Hill strategy will fail. It is sure to lead you into error because by the time you see the whites of their eyes, they’ve already shot you right through the heart.

Is this why the Fed today believes it should raise rates? If not, what is/are the reasons? The labor market has been steadily improving, but certainly has not been on fire. There are no signs of inflation anywhere, not current or expected. Wages have been fairly stagnant. Forward guidance and the Fed’s “threshold” unemployment number, 6.5%, have come and gone. The only explanation seems to be that there is a desire to return to normal monetary policy making and  rates have to go up at some point.

by Thomas Cooley and Peter Rupert

Today’s GDP report reveals Q2 growth of 2.3% for the advance estimate. Overall, this tepid increase provides is not going to be an inducement to hike rates at the next meeting of the FOMC. First quarter GDP was revised upward to 0.8%, better than the initial estimate of  a  -0.2% decline.

But, as the above graph makes clear, the last three quarters do not show much evidence of robust growth. The bad news in the report is that second quarter growth was fueled in part by a big surge in inventories, a fact that could weigh on growth prospects in future quarters. Also discouraging was the downward revision to the longer term picture of GDP growth.

Annual Revision

Each year the BEA performs an annual revision, mostly covering the previous three years, but for some components goes back even farther. The result of the revisions show somewhat weaker growth compared to the previously published estimates. From the BEA release:

• From 2011 to 2014, real GDP increased at an average annual rate of 2.0 percent; in the previously published estimates, real GDP had increased at an average annual rate of 2.3 percent. From the fourth quarter of 2011 to the first quarter of 2015, real GDP increased at an average annual rate of 2.0 percent; in the previously published estimates, real GDP had increased at an average annual rate of 2.2 percent during this period.
• The percent change in real GDP was revised down 0.1 percentage point for 2012, was revised down 0.7 percentage point for 2013, and was unrevised for 2014.

Since the “end” of the recession in 2009 growth has been lackluster, although investment has experienced faster growth, having declined more dramatically as is usual over the business cycle.

The FOMC and Moderate Growth

The recent policy statement from the FOMC used the word “moderate” twice in the first two sentences when talking about economic activity and household spending. As can be seen in the graphs above, both GDP and PCE grew in lock step over that past several years, and grew 2.3% and 2.9%, respectively for Q2.  The GDP price index grew at 2.0% (1.4% for the core) and the PCE price index grew at 2.2% (1.8% for the core PCE price index), all of them right around the 2.0% FOMC target. And, while they mentioned the housing sector has shown additional improvement, “business fixed investment and net exports stayed soft.”

Evidently, the FOMC is putting more weight on what happens in the labor market: “The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”

by Tom Cooley and Peter Rupert

The employment report released on Thursday, before the July 4 holiday on Friday, revealed an employment gain of 223k, but the overall report left a little something for everyone, depending on point of view. The 223k number was slightly less than what many had forecast. All of the increase came from private employment as there was no change in government employment. On the negative side,  there were downward revisions for the past two months, April down by 34k and May down by 26k. In fact, the revisions have all been down since January.

Average weekly hours remained at 34.5 for the fourth straight month and hourly earnings were basically flat.

The household data from the CPS was a little more discouraging. Yes, the unemployment rate fell to 5.3%. However, the labor force fell by 432k and the number employed fell by 56k, as did the employment to population ratio, falling to 59.3.  Labor force participation is at an historic low.  So there is no way the labor market could be described as in a robust state. The long term unemployment rate – those unemployed 27 weeks or more  diped sharply.

Many of the remaining problems in the labor market – participation rates, long duration unemployment – appear to be structural, not cyclical.  The structural issues have a lot to do with the way the economy changes over the business cycle, the loss of mid-level human capital jobs, a feature that has been pronounced over the past few cycles. It seems unlikely that the Fed will view these problems as impediments to a more normal monetary policy.

The JOLTS data released this morning shows the number of vacancies, 5.4 million, is the highest since the series began in December 2000, and the job openings rate also remains high, higher than at the peak of the previous cycle! However, the hiring rate fell in May, to 3.5% from 3.6% in April. Layoffs and discharges fell slightly and quits were basically unchanged.

By Zach Bethune, Tom Cooley and Peter Rupert

Today’s GDP release from the BEA reveals a modest upward revision in GDP for the 1st quarter from -0.7% to -0.2%. Though still in negative territory the upward revision is certainly welcome. As noted by the BEA, “…primarily reflecting upward revisions to
exports, to personal consumption expenditures, to private inventory investment, to nonresidential fixed investment, and to state and local government spending that were partly offset by an upward revision to imports.” The revisions were pretty much across the board.

Real personal consumption expenditures increased 2.2%, the weakest recording since the first quarter of 2014. Tomorrow, the personal income report comes out that will give a little clearer picture of the path of consumption to date.

The signals coming in concerning the economy are mixed, making it extremely difficult to gauge upcoming policy moves. The latest meeting of the FOMC along with their statement seems to have left many Fed-watchers, prognosticators, and others suggesting that the Fed is on a path to raise rates in the fall or possibly winter. For example, Jon Hilsenrath of the WSJ says,

The Federal Reserve signaled Wednesday that it was moving toward interest-rate increases later this year, with the economy now firmer after a winter slump, but officials emphasized they would move even more cautiously than expected.

While many seem to suggest that the Fed is on pace to raise later this year, there is certainly nothing in the Fed statement that leads to such a conclusion. Just in case you are confused with Fed-speak, here is another statement…from 2011,

To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.

The point is that, as the June statement emphasized, the risks are balanced. Meaning that raising rates soon is kind of 50-50. And, as the statement now always reminds us, any future moves are data dependent. So, looking forward, while the risks might be balanced, the risks are many:

• Uncertainty in Greece continues to plague policy makers and investors….but it seems now likely that many have already priced these risks in the market.
• Europe continues to have winners and losers, making it difficult to have much faith in any overall forecasts.
• How will China respond to what appears to be lower growth?

In terms of the US, nothing seems to really stand out yet that would call for the beginning of liftoff. Yes,  employment has risen steadily, albeit slowly…much slower than earlier recoveries…and the unemployment rate is relatively low but labor force participation is also low.

Still, there are many signs of either slow growth or real weakness to offset those indicators. There is really no sign of inflation anywhere, not recently nor in expectations. While the labor market is seeing signs of strength there does not appear to be any wage pressure, and the employment cost index has popped a little recently, but again, is still relatively subdued.

Average hours have remained pretty flat after picking up several months ago. Moreover, one indicator many use to gauge the health of the economy is output per hour of work (productivity). There also isn’t any real positive news here either as productivity has fallen for two consecutive quarters, the last time this happened was back in 2006.

While job openings are near all time highs, the hiring rate continues to climb, but quite slowly.

Some economists look at the Beveridge Curve (vacancies vs. unemployment) to see how the labor market is matching job seekers to job vacancies. While the Beveridge Curve has “looped” back, the unemployment rate is about a percentage point higher, given the vacancy level, that it was back in the early 2000’s. One interpretation is that the market is having a more difficult time matching workers to firms, for example, from skill mismatch.

The labor market also looks quite different compared to the early 2000’s in both the employment to population ratio and labor force participation. Both are a long way from their peaks and have remained remarkably flat. Unfortunately, there is little by way of economic theory to enlighten us on what the “right” long run value should be for either statistic. Perhaps the late 1990’s and early 2000’s were unsustainable, and now we are back at more sustainable levels.

Moreover, there is still a substantial fraction of the unemployed who have been in that state for more than 27 weeks. This certainly does not bode well for such workers and it remains to be seen where and when they will eventually land.

So, in the end, what does all this mean? It simply means that the shape of the economy is in the eye of the beholder. Data can be presented to bolster either view…to raise or not raise this year. Indeed, the FOMC statement was clear about the cautious outlook:

This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.

The latest inflation numbers do not seem to suggest yet that one would be “reasonably confident” that inflation has moved back to its 2% objective, as the chart below shows, that inflation indicator has often been below the 2% (red line) for much of the time…and the latest reading shows a 2.0% decline. The quarter before saw a 0.4% decline.

By Zach Bethune, Tom Cooley and Peter Rupert

According to the BLS payroll employment increased by 280,000 with nearly all of that coming from private sector jobs, which increased 256,000 . The report also included an upward revision to March of 34,000 and a slight downward revision to April, -2,000. The goods producing sector was weak, adding only 6,000, with evident weakness in the petroleum sector: mining and logging shedding 18,000 jobs.  Fortunately, now the March decline in new jobs looks like an outlier with the economy adding a healthy number of new private sector jobs each month.

Other than the goods producing sector and a small decline in the services “information” category, the gains were robust across all sectors private and public. Although average hours were flat as were average hourly wages, but because inflation is so low, real earnings ticked up somewhat.

From the household survey the BLS reports an increase in the labor force of 397,000 and a slight uptick in the labor force participation rate as well as the employment to population ratio. These are encouraging signs the employment opportunities may be seen as improving.

There was also a decline in the number of persons unemployed less than 5 weeks, there are now 311,000 fewer. However, there is still a significant number of those unemployed over 27 weeks, that number fell by only 23,000, while those unemployed between 5 and 26 weeks increased by 379,000. The longer term unemployed are much less likely to find work and it has proved to be a persistent problem as those workers are likely losing skills while not at work. Moreover, those unemployed more than 27 weeks represent about 26% of those unemployed.

However, there are other encouraging signs in the labor market. Quits continue to rise.

And, there has also been a significant spike in those workers working part time for economic reasons transitioning to full time employment.

by Zach Bethune, Tom Cooley, and Peter Rupert

Today’s second estimate of Q1 GDP issued by the BEA reveals a downward revision of nearly one percentage point, from 0.2% to -0.7.

Many prognosticators envisioned an even larger drop so this “restrained” decline might not send shock waves across markets…unless, of course, there are other signs of weakness moving forward that might signal weaker Q2 growth. For example, inventories were revised down by about half of what people thought, $15.2 billion. While personal consumption expenditures saw almost no revision, the (expected) downward revision in exports materialized, revised down by $26.3 billion. Final sales also saw a big downward revision compared to the advance estimate, from -0.5 to -1.2.

Residual Seasonality and GDP vs. GDI

A recent report from the San Francisco Fed argues that the large revisions to first Quarter data and the remarkable weakness in the first quarter for the last few years may be the result of “residual seasonality” rather than fundamentals.  Economists at the Federal Reserve Board reached a similar conclusion.  The Bureau of Economic Analysis is looking at this issue and will incorporate their conclusions into the July revisions to GDP. Many expect that review to result in a .5% or so upward revision of the data In our view it would be a mistake to attach too much importance to this possibility.  The first quarter was unquestionably weak for reasons that were quite foreseeable. Some of it was bad luck (i.e. bad weather and port strikes) but some of it was fundamental – lower exports because of a stronger dollar and weakness in other economies.

The more important issues are twofold: How does this bear on the argument that we we are caught in a period of “secular stagnation” as former Treasury Secretary Larry Summers and others have argued. And, how does the weaker economic growth impact the probability of Fed “liftoff” in the near future.  On the first question it would be hard to refute the idea that U.S. potential GDP has shifted down a notch. Compared with previous recoveries this one continues to be anemic. There has also been a distinct slowing of both residential and non-residential fixed investment that does not bode well for future growth of the economy.

Another theme that has emerged is a discussion of the merits of looking at Gross Domestic Income (GDI) vs. GDP. The argument is that GDI is a better gauge of the economy than the traditional Gross Domestic Product (GDP) measure. The reasons given can be found here and here. As the graphs below show, however, this is certainly not a matter of using one or the other.  Each has shown lackluster performance. In NIPA theory these two measures are equivalent, but, GDP and GDI do differ at times. Over a long time frame, they do indeed almost perfectly rest on top of each other.

If we zoom in to the recent experience since 2007, real GDI has performed better than real GDP. Indeed it is the end points that signal a decline in real GDP but not in real GDI…

…but it was the opposite in the early 1990’s when real GDI does worse than real GDP.

However, the main point to be made here is that using either one tells a story of an anemic recovery since the Great Recession of 2007, and splitting hairs over GDP vs. GDI seems a minor issue.

All of these factors are going to caution the FOMC when it meets in June because the last thing they want to do is derail a recovery that is now both mature and showing some signs of weakness. By and large the labor market seems to be operating near full employment, albeit without wage growth. Whether the first quarter weakness signals a more prolonged slowdown won’t be known for some time but it seems likely to put liftoff on hold for a while.