Volume 59, Number 1 | April 1, 2011
Payroll employment rose a solid 216,000 in March, trimming the unemployment rate by 0.1% to 8.8%. In the first quarter, payrolls rose an average 149,000 — for the first time in this recovery, achieving job gains that if sustained would lower the unemployment rate assuming normal labor force growth. This is the bare minimum condition for the Federal Reserve to even begin thinking about ending their easy monetary policy. Unfortunately, it is still the bare minimum and the economy faces growing headwinds as we move toward the second half of the year — from the end QE2, growing fiscal austerity (particularly at the state and local level), and the delayed impact of higher energy prices. The issue of supply chain disruptions caused by the Japanese earthquake is still an open question. Given that most of the effects for the US will first show up in April, the question is whether they will be severe enough to damage growth in the second quarter or just shift production into May and June. Right now we see second quarter real GDP growth at 3.0%, up from 2.3% in the first quarter. We expect real growth to stay near 3.0% in the second half as higher interest rates and energy prices, combined with cutbacks in the public sector restrain the positives from private sector growth. With growth just slightly above potential, the current slack in the economy will not disappear quickly and we expect the Fed to remain on the sidelines.
Despite the focus on improving employment, the economic picture is not significantly different now than in the second half of 2010. In the first quarter of 2011, private hours worked by nonsupervisory employees rose 1.8% compared to the fourth quarter at an annual rate. They rose at the same rate in the second half of 2010. The difference is that in the first quarter, there was no growth in hours for existing employees, so all of the new hours resulted in more jobs. In the second half of 2010, roughly one third of the gain in hours accrued to those who were already working. In the first half of 2010, two-thirds of the gain in hours went to existing employees. We expect real GDP in the first quarter of 2011 was slightly depressed by weather which reduced the productivity of those hours worked. A return to normal in the second quarter – which assumes limited supply disruption from Japan – would return growth to just slightly better than in the second half of 2010. We do not see any weakness in 2011, but we do not expect the economy will be able to sustain 4% growth for more than short spurts – as growth that strong would likely lift interest rates and energy prices quickly enough to damp future prospects.
Two factors limiting the income generated by sustained future growth in hours worked are the loss of unemployment benefits and slower growth in wages. The personal income report for February, released just ahead of the March jobs report this week, showed that private sector wages and salaries rose at a 3.9% annual rate, or $51.2 billion, in three months ended in February — but just over one-third of that gain was offset by a $17.8 billion decline in unemployment benefits. More workers are expected to come off the unemployment rolls in coming months, either because they have found jobs or because they have exhausted their benefits. With the extension of emergency benefits highly unlikely, the loss of unemployment payments will be a significant headwind in the second quarter. Meanwhile, wage growth for existing workers continues to slow – especially relative to accelerating consumer prices. In February, the average hourly wage for non-supervisory workers fell -0.1%, compared to a 0.5% rise in the headline CPI. Over the last three months, wages are up at just a 1.5% annual rate, only a fraction of the 5.6% annual rate for the CPI over the same three months. From a year ago, wages grew slightly faster than CPI – at 2.0% based on a 3 month average, while CPI rose 1.7%. Wage growth normally lags the decline in hours worked by at least a year and often much longer. We expect wage growth will remain soft for the remainder of 2011, leaving existing workers with declining buying power. Though the macro picture may be improving as firms begin to hire back workers, we are far from where a rising tide lifts all boats.
Nowhere is the disparity in the recovery clearer than in the rise of the stock market compared to the ongoing slump in home prices. Stocks and home values both soared from 2003 through 2007, only to crash to earth in 2009 – giving back all of the gain during the previous six years. Since the bottom in 2009, the equities market has almost doubled to stand roughly 10% below its previous high. Meanwhile, home prices have gone nowhere and remain 32% below their peak in June 2006. Given that the US housing stock was leveraged by roughly 50% at the peak, the decline in equity was twice as bad. For the vast majority of Americans, their home is by far their largest investment – and for younger home owners, who face the toughest job market, the leverage is the highest. If long term interest rates rise in the coming year, as the vast consensus of Wall Street forecasters believe, home values – and home equity — will decline even further. Tough to see a strong consumer with home prices still falling.
We believe that the housing crisis is far from over — and that it remains the greatest headwind to this recovery. Long before price increase turn into sustained inflation that justifies higher ten year notes, those higher rates will destabilize the housing sector and renew the threat to the US banking system – especially among small banks. Even without inflation fears, concern about the dollar and rising US deficits threaten higher interest rates – again putting housing, banking, and the recovery at risk. Though everyone wants real GDP to grow at 4% in order to create jobs and sustain the economy, it is not at all clear with the housing overhang whether the economy can get there from here. Sustained, but disappointing, growth near 3% seems more likely keeping unemployment high, the Fed on the sidelines — and calls for austerity frequent, but unanswered, as the election approaches.