Monday, February 29, 2016

The FOMC's conundrum

If it was just about latest wage and inflation data the FOMC would be tightening in March.  Both are clearly trending higher with the Committee's preferred measure of inflation, the core personal consumption expenditure (PCE) deflator, now also heading upwards.   A larger than expected rise in January took the annual rate of increase to 1.7%.  The latest FOMC Summary of Economic Projections didn’t expect core PCE inflation to reach 2.0% until 2018.

But it’s never that simple.  The question for the FOMC is where inflation is going, the answer to which is becoming increasingly complex.  Indeed the FOMCs January statement showed the Committee was clearly struggling with the implications of the recent heightened market volatility for US and global growth.  Also the full impact of the recent strength in the USD on the economy is yet to be determined.

Our read of the recent activity data is that it hasn’t been that bad.  Where there have been weaker signals, such as consumer confidence and the non-manufacturing PMI, they can be tied back to market volatility, the weather and the fallout from lower oil prices.

We started the year thinking US GDP growth would come in around the top of its recent 2.0-2.5% range.  It’s now more likely to come in around the bottom of that range, still dependent on continued labour market expansion and solid increase in aggregate labour income.  Importantly that will still have the US economy growth at a little above potential which the Congressional Budget Office has averaging 1.8% over the 2016-2020 period.

If we’re right and growth continues to run ahead of potential the unemployment rate can be expected to continue to fall, absent a rise in the participation rate, and wages and inflation continue to trend higher.  Until that becomes clear and the FOMC has more confidence in that story, the Committee will sit on their hands.  

Monday, February 15, 2016

US Labour market, retail sales consistent with continued economic expansion

Our view is continued improvement in the US labour market will support solid consumer spending and keep the economy on track for another year of modest growth.  Latest labour market indicators including the JOLTs and NFIB surveys remain solid and jobless claims dipped lower again, supporting the argument the weakness of the past few weeks in that series may have been due to seasonal adjustment issues.

The Job Openings and Labor Turnover Survey (JOLTS) showed no sign of a cooling labour market.  Job opening stood at 5.6m in December or an annual growth rate of growth of 3.8%.  The Quit Rate is now at +2.1%, a high for this expansion.  This reflects people finding better job opportunities in a well-performing labour market.  This is also positive for wage growth as people mostly leave their current job for better prospects and higher pay.

 The NFIB small business survey dipped lower in January, most likely due to the volatility in the share market.  Hiring plans fell to a net +11, so lower and consistent with a lower level of payrolls growth in January.  But labour market tightening could be a factor.  As the economy gets closer to full employment full employment labour hiring slows and it gets harder for firms to find the right people for the job.  In this survey 29% of businesses with job openings reported having difficulty finding the right person, a high for this expansion.

Retails sales were really strong following the disappointing December result which was revised up and now suggest the US consumer ended the year in fine fettle.  Control group sales (the part that feeds directly into GDP) were up +0.6% in the month suggesting retail spending is off to strong start in 2016. 

None of this makes the FOMC’s job any easier in determining the outlook for interest rates.  The critical judgement for the FOMC is to decide whether recent economic and market developments leads to a slowdown in growth and whether the softness in some labour market indicators are genuine softness or simply characteristic of late cycle labour market developments.   Last week’s Congressional Testimony suggests FOMC Chair Janet Yellen is keeping an appropriately open mind.

We continue to believe recent weakness in the data is transitory in nature due to the inventory cycle and the sharp slowdown in oil-related investment and that fears of recession are well wide of the mark.  We put the probability of recession at 25%.

Monday, February 8, 2016

Payrolls soft, rising labour costs

After another batch of generally soft US data during last week all eyes were on Friday’s payrolls data, particularly for hints about the next move in US interest rates.  As it turned out the signals were mixed.

Employment growth was +151k in the month, lower than expected and a noticeable slowdown from the stellar pace of jobs growth in the fourth quarter of last year that saw payrolls expand at an average +279k per month.  The question is how much of this is genuine slowdown and how much is seasonal.

The detail had some quirks and didn’t help clarify the story much.  While I don't buy the US recession story, the economy is a story of two parts.   Manufacturing is the sector closest to recession for all the reasons we’ve discussed before, yet manufacturing jobs rose +29k in the month.  Jobs growth in the service sector was +118k, still strong but weaker than late last year and consistent with the drop in the services PMI employment sub-index seen earlier in the week.

The unemployment rate ticked lower to 4.9% despite a move higher in the participation rate.  We’ve been expecting to see some cyclical pick up in the participation rate which would likely moderate further declines in the unemployment rate, but such was the strength of employment growth in the household survey that unemployment ticked lower regardless.

Some bounce had been expected in wages following a flat December month. Average hourly earnings were up 0.5% in the January month and 2.5% in the year.  This combined with last week’s poor productivity growth (+0.3% for calendar 2015) will have the FOMC’s cost-push models suggesting higher interest rate are warranted.

 But some of the activity indicators have been undeniably soft.  I still think a good part of the weakness we have seen recently will prove transitory.  I liked the blip higher in the “new orders” component of manufacturing PMI and I think the weakness in the non-manufacturing survey is largely related to poor core retail sales growth at the end of last year that was in part due to the good weather and poor clothing sales.

How the Committee balances concerns about growth with concerns about inflation is key to the outlook for interest rates.   Right now the pace of growth in jobs and unit labour costs are consistent with a more gradual pace of rate hikes than the four indicated by the FOMC (which we always though would be too aggressive), but more than the none indicated by the market.  

Wednesday, February 3, 2016

Sharp fall in the New Zealand unemployment rate

The labour market bounced back strongly at the end of 2015.  Employment rose +0.9% in the December quarter, coming back strongly from the surprise -0.5% dip in the September quarter.  Annual employment growth came in at 1.4% for the calendar year.

The surprise came with a sharp fall in the unemployment rate from 6.0% in September to 5.3% in December.  Despite another strong increase in the working age population, the participation rate recorded its third consecutive quarterly decline to 68.4, down from 68.7 in September and 69.5 at the start of 2015.  The latest level is still high by historical and international standards – it’s just not as high as it was.

Wage inflation remained muted. In fact the annual rate of increase in private sector ordinary time labour costs continued its drift lower, coming in at 1.6% for the year.

This mix of data doesn’t make the Reserve Bank’s job any easier.  This result along with the bounce back in GDP growth tells us the New Zealand economy ended 2015 in better shape than it started it, but with subdued domestic inflationary pressures.   

Having lowered the OCR back to the historical low of 2.5%, we expect the Bank to hold fire on further rate cuts in the near term, but retain a bias to reduce interest rates further should conditions warrant.

Monday, February 1, 2016

Don't fret about US growth

It has been an angst-ridden start to the year with concerns about global growth the major cause of all the consternation.  For those of you who have read the latest edition of QSO, you already know we think those concerns are largely overdone.  Fourth quarter 2015 US GDP data released last week didn’t help alleviate those concerns, but there was nothing in that report to alter our view that the US economy will enjoy a third consecutive year of above trend growth of 2.0-2.5% in 2016.

Much of the weakness in the low quarterly (annualised) result of +0.7% was for reasons that were well-flagged and that will ultimately prove to be transitory.  Inventories provided a second consecutive quarterly drag on growth while net exports shaved 0.5% off growth in the quarter. Business investment was flat over the quarter but that as largely due to weakness in “petroleum extraction structures” (i.e. rigs), outside of which investment remained solid.

On a more positive note consumer spending was solid (+2.2%) over the quarter, despite the drag from utilities spending given the unseasonably warm weather over the quarter.  Also residential investment (+8.1%) continues to benefit from the increase in household formations and still low mortgage interest rates.

But we don’t completely dismiss the weakness in the economy at the end of last year.  The best indicator of what you might call “core growth” is real final sales to domestic purchasers which came in at an annualised rate of 1.6% in the fourth quarter, down from 2.9% in the third quarter. 

Right now our view is for continued above trend GDP growth of 2.0-2.5% in 2016.  A combination of solid jobs growth, increases in the average working week along with modest wage growth is expected to lead to continued solid gains in aggregate labour income and consumer spending.   Our read of the forward looking labour market indicators remain consistent with this story.  Furthermore we also believe we haven’t yet seen the full benefit of the real income gains that have come from weaker oil prices. 

The biggest risk to our view is weaker than expected jobs growth and any deterioration in the recent trend improvement in consumer confidence.  The weather also appears likely to cause disruption again in the early part of the year.  We will be watching that data closely in the weeks and months ahead.

No doubt the FOMC will also be watching closely.  The Committee’s “dot plot” forecast suggests four hikes this year.  We have been assuming three but acknowledge the risk is biased to less rather than more.  The latest data and market volatility suggests the pause may come earlier than we thought.  Markets are pricing in only a 14% chance of a hike in March which doesn’t seem unreasonable right now.  The Committee will need to see firm evidence the growth weakness at the end of last year is indeed temporary.