Volume 60, Number 1 | July 8, 2011
Financial markets move in a different time frame from the real world, as investors rush to be the first to take advantage of good or bad news. When the news changes directions frequently, as during the current uncertain economic and political environment, financial markets become particularly volatile with a lot of sound and fury signifying nothing – for economists. Real businesses simply can’t stop on a dime and change directions like financial markets. The recent drop in oil prices and interest rates has barely had time to register in the real world. We are still bound in a wide trading range as businesses await clearer instructions on the direction of taxes, spending, healthcare and regulation both at home and abroad. The apparent Greek bailout is unraveling as rating agencies indicate that they too have a voice in the debate. Like the British regulators who scuttled the Lehman deal, they represent the constituency that was being ignored during these deliberations – holders of credit default swaps. The rating agencies need to rebuild their reputations with the financial community even more than they fear angry German regulators. Meanwhile, Republicans are still backing away from the negotiating table even as President Obama ups the offer every day. Obama is wary of a solution that requires a second round just before the election, while Republicans are even more wary of any solution that will aggravate the Tea Party sparking new third party candidacies or internal primary challenges. It is not easy to resolve problems quickly in a democracy full of checks and balances. The angst of the financial markets is but one of many signals to which politicians respond. We had hoped the market sell off would generate action. Now, a far more powerful force is being brought to bear – jobs, or the lack of them, which translates into angry voters. Unfortunately, the angry voters want different things, some more government assistance, other significantly less. That’s why we have elections, but they are still sixteen months off! Bottom line, it is tough to forecast strong growth before the fundamental imbalances are addressed.
No Redeeming Value
This month’s jobs report was about as bleak as possible. The payroll report showed a disappointingly small 18,000 new jobs and revised away another -44,000 from the previous two months. The more volatile household report saw a hefty -445,000 jobs lost and a rise in the unemployment rate to 9.2% despite a -275,000 decline in the labor force. The labor force today has fallen -1.532 million from its peak in October 2008. It is virtually the same as in September 2007 – just before the recession (depression?) began — and during that time we have lost 6.9 million jobs according to the household report and 6.7 million in the payroll report. While the labor force was likely skewed to the high side in late 2007, it is certainly skewed to the low side now as many job seekers have just given up. Thus, the pain of unemployment is significantly higher than mere statistics tell. We remain quite fearful that the US may slide back into recession sometime over the next two years with an unemployment rate well over 8% (in the narrowest measurement) and a budget deficit still at 8% of GDP, with the dollar already at decadal lows, interest rates near zero, the Fed’s balance sheet still extended and no policy levers left to pull. Given we are already two years into the “official” recovery and three and a half years from the start of the last recession, this is not a black swan risk but a very real (say 25%) possibility – but with catastrophic consequences.
The weakness in the jobs report should not have come as a surprise. Real GDP in the first two quarters of this year has hovered around 2%, far below the 3.5%+ expectations at the start of each quarter. After a weather affected January, and subsequent strong hiring in February through April, firms realized they had over hired and were forced to make adjustments in May and June – both months where hiring is traditionally quite strong. Even after the sluggish hiring in the past two months, the private sector has added an average 156,000 new jobs per month during the first six months of the year while real GDP has risen at just a 2% annual rate. This is well above the 124,000 recorded in the fourth quarter when real GDP growth was last above 3%. With the average workweek up just 0.3% in the first half of 2011, job growth translates into roughly 1.0% productivity. Given business’ laser like focus on the bottom line, the mismatch between hours and output was not likely to persist – and may not be over as the typically leading household employment measure still points lower for both public and private sector jobs.
The Not So Big Bounce
In the short run, the key to faster job growth is the long awaited bounce. Unfortunately, with initial claims for unemployment At 418,000 in the first week of July – barely discernable from the 425,000 average of the previous eight weeks, the bounce may be less than expected. We had hoped claims would drop to below 400,000 in the first week of July and under 350,000 in the second week. State claims data from last week shows that claims are already back to near normal in the Japanese dependent auto states that were hardest hit by the supply chain problems. However, claims have been rising elsewhere generating the disturbing 432,000 (after revisions) print in the last week of June. Now, whatever reduction in claims comes next week from auto workers unseasonally on the job will be partially offset by Minnesota state workers unseasonally off the job due to their government shutdown. Meanwhile, high inventories of trucks at GM are already leading to cutbacks on planned auto output in the third quarter. Firms need to see forecasts of 3%+ growth going into 2012 to begin hiring as aggressively as they were in February through April. Unfortunately, after this month’s jobs report they are likely to be headed the other way.
Perhaps the most distressing aspect of the jobs report was the lack of income growth it signals for wage earners. Not only was job growth soft at a mere 0.05% growth rate, but the average workweek for nonsupervisory workers was unchanged while hourly pay fell by -0.05%. Thus, nominal wages remained unchanged in June from May. It had been hoped that as falling energy prices cooled inflation in June, real wage growth would shine through. After all, strong nominal wage gains of 0.4% in recent months had been largely wiped out by sharp increases in headline inflation. However, with gains in real disposable income for wage earners still stymied, the outlook for the largest sector of the economy remains troubled. As a result, the burden of growth for the economy remains on increased spending from the corporate sector, if and when they decide to reduce their extraordinarily high savings rate.
Peering Through a Murky Windshield
The next several weeks will provide businesses own best estimate on where profit are going as they report earnings and provide guidance for the second half of the year. It is important to note that the survey for this employment report was taken in the week of June 12th, before the latest “victory” on the Greek crisis was reported and before Wen Jiabao claimed victory on inflation in China. The equity markets subsequently rallied sharply on those pieces of news – and now are retracing that optimism on the jobs data and far less conviction about the victories abroad. From a macro perspective, it will be important to see if corporate caution on jobs at least preserved strong profits – as it did in the first quarter – holding out the prospect that firms with strong balance sheets can invest when they perceive the current murky political environment is clearing. Their guidance will provide insights on whether firms will invest and hire or continue to hunker down. This is particularly important for purchases of capital goods – so far the strongest sector in the US economy during this expansion – as 100% expensing is widely anticipated to pull forward economic activity into the second half of the year.
To put the weak jobs reports of the past two weeks in the rear view mirror, there must be improvements in forward looking indicators like guidance and new orders. Employment is only a coincident indicator, confirming what we knew – that the economy was soft in the second quarter. Even claims is only a coincident indicator – albeit one that appears sooner than other employment measures and more frequently. Falling interest rates and falling oil prices typically translate into stronger growth – but with a lag and only if they are maintained long enough for the real economy to react. The recent drop in mortgage rates has generated virtually no response in either home sales or refinancing. So far the drop in oil prices has not resulted in a correspondingly large decline in gasoline prices, but $3 gas is likely by Christmas due to seasonal patterns. The rebound in new orders seen in the various ISM reports offers hope, but it must be reinforced – and soon – for the economy to benefit from the bounce.