Volume 58, Number 5 | February 7, 2011
Once again we find ourselves watching Wall Street try to put a bullish spin on a bearish number. Payroll employment rose a far weaker than expected 36,000 jobs in January – and the details confirmed our concerns that businesses are still far from starting a hiring binge that could spark a broader expansion. Sustained growth between 2.5% and 3% seems the most likely outcome for 2011, with many headwinds slowing growth in the second half of the year and into 2012.
Though we are concerned about the ultimate duration of this expansion, especially with everyone else in the world already tightening policy, those concerns are more about 2012 – as policy changes work with a long lag. Indeed, much of what is still keeping this expansion afloat is the stimulus packages and loose monetary policy started one and two years ago. However, that stimulus is coming to an end and we still do not see the handoff to the private sector. Normally, housing and autos are the first wave. Housing remains moribund, with rates headed higher into the key spring selling season. Autos, while stronger, are only expected to rise another 10% in 2011. As they only represent about 3.4% of nominal GDP, the impact of this gain is likely to be overwhelmed by the loss of stimulus. As the ISM data shows, manufacturing is already booming. It is the much larger services sector – often small businesses – that are merely limping along. With stimulus fading and manufacturing hitting on all cylinders, we worry that the best is already behind us in this cycle and that the US economy will becoming increasingly susceptible to policy mistakes made around the world as we move into 2012.
Whether the Weather…
Clearly the weather affected the payroll report, but not by 100,000 jobs. Given the consensus going into the report was about 140,000, that suggests a weaker than expected performance, no matter how you try to spin it. The clearest example of a weather related decline was in couriers which fell 45,000 – accounting for more than the entire 38,000 decline in the transportation sector. Similarly, construction fell 32,000, but it had been falling an average 13,000 in the previous two months. These weather related declines are also responsible for most of the drop in hours worked and surge in average hourly earnings, as it was primarily low pay workers who missed their paychecks.
However, other areas typically affected by weather, barely fell, suggesting this winter’s storms were not far outside the norm. Leisure and hospitality lost only 3,000 jobs. Temporary employment fell by 11,000, but the more likely explanation is that many temps found full time work in the booming manufacturing sector, which saw employment rise by 49,000. Indeed, one of the most disconcerting things about the report was that it was so weak while manufacturing was so strong. Meanwhile, traditionally strong areas like health care were softer, reflecting the slower spending growth on health care seen in the fourth quarter GDP report. Government employment has been steadily negative in recent months as tighter budgets force cutbacks, primarily through attrition. Bottom line, even allowing for weather, we see job gains in January at around 100,000, consistent with the 107,000 average of the previous two months.
Also, we are far from impressed with the decline in the unemployment rate to 9.0%. The percentage of the eligible population in the work force has fallen by 0.6% over the past year, leaving the labor force 167,000 smaller than in January 2010. Each January, population controls are made on the data making December to January comparisons less trustworthy. However, the trends in employment are underwhelming, with just 812,000 new employees in the household report over the past year (January to January) compared with 984,000 in the payroll survey. Bottom line, the new 9.0% level may be more politically appetizing, but it is still not falling through employment gains. Indeed, the problem of long term unemployment appears to be coming more intractable as workers simply stop looking.
Where We Are
We are not denying that there have been stronger economic signals lately. The Chicago PMI and ISM signal a manufacturing economy that is red hot. The employment numbers appear to confirm that factories are adding full time employment at a rate not seen in years. And, that makes complete sense when one looks at the strength in export sales in recent months. However, the strength in manufacturing employment alone is not enough to carry the economy. Productivity gains are much higher in manufacturing limiting compensation gains and the pass through into the rest of the economy.
Nor does a manufacturing/export boom loosen the purse strings at the banks. It is not bad loans to factories that are holding back the banks. It is still real estate that lies at the core of the banking problems, and there is no sign in the data that those imbalances – either in residential or nonresidential — are getting significantly better. Indeed, with ten year notes now pushing up to 3.65% and likely headed higher on inflation fears, mortgage rates could be back over 5% as we move into the spring selling season. Higher rates, tougher down payment requirements, no subsidy, and limited real gains in consumer buying power all point to lower home prices in the spring – despite the normal seasonal upturn. Banks are unlikely to expand their loan book when bad debts remain so onerous and the foreclosure process is still depressing prices. The export boom may continue, because foreign buyers get their funding from foreign banks, but the domestic outlook remains sluggish. If foreign restraint slows the export boom in 2012, we don’t see the US domestic economy picking up the ball.
The bottom line is that it still looks to us like we need significantly lower interest rates, especially at the long end of the curve, to allow refinancing to clear part of the debt overload. Write downs by institutions with strong cash flow – from borrowing at the Fed mandated near zero rate and lending it back to the government or other sound borrowers at higher rates – will erode the problem gradually. None of this is a quick fix – and the chances of a larger wave of refinancing and write-downs are more likely in the next downturn, not as a result of coming strong economic growth. Interest rates are the regulator of every economic cycle, whether set by the Fed or by foreign investors’ demand for protection against potential US inflation and or dollar declines. Rates are rising in 2011, as they did in the spring of 2010, and we expect at least a pause that refreshes as a result in coming quarters.