For a Federal Reserve (Fed) that reminds us at every juncture that they are data dependent, the data really threw them a curveball last week. While a data dependent approach seems like the obvious choice on the face of it, it does put one at the mercy of data that can point in different directions at the same time. Not to mention the fact that macroeconomic data has a high degree of variability.
An ugly payroll report
Case in point was Friday’s payroll report for May, which was ugly considering the labor market was widely thought to be strengthening based on recent numbers. Only 38,000 jobs were created in May while April was revised down to 123,000 (from 160,000). This compares to an monthly average of 224,000 jobs during the first quarter and 229,000 in 2015. May’s payroll numbers were the lowest monthly growth since September 2010.
Couple of things to note here: monthly payroll numbers have a high degree of variability, with a mean absolute revision of 55,000 between the first and final estimate. Also, a strike at Verizon cut job growth by about 37,000 but the strike ended last week and these jobs should show up again in the June report.
Headline unemployment rate fell to 4.7% in May from 5% in April, but even this was because fewer people reported looking for work as opposed to more people finding work. Particularly troubling is the fact that the last two months have almost completely reversed a six-month rise in labor force participation between October 2015 and March 2016. While the participation rate is expected to fall based on long-term demographic trends, the recent upswing against this trend was a huge positive. However, it appears that some of the rise may have been due to survey volatility.
The one positive out of the report, at least on the face of it, was that wages continue to grow around 2.5% annually and since core inflation has been running around 2%, there has been some real wage growth. Yet for a labor market that is supposedly tightening, this is still quite meager and disappointing. Wage growth has stopped accelerating and has meandered around the 2.5% mark for more than six months now. Bear in mind that wages were growing at a rate of 4% prior to the Great Recession. The May payroll report indicated that the number of unemployed persons in the civilian workforce fell by 484,000 but the number of employed persons working part-time for economic reasons rose by 468,000 in May, suggesting slack still exists in the labor market.
The remaining headline data released last week was definitely a mixed bag. Let’s start with the more positive headlines.
Unemployment claims remain low
The number of people filing unemployment claims fell to 267,000 in the week ending May 28th, the 65th straight week with claims below the 300,000 level, pointing to labor market strength. Claims are close to their lowest levels since the early 1970s.
Auto sales continue to provide cheer
Light vehicle sales rose to a 17.4 million annualized rate in May, up 1.5% from the previous month. At the same time, sales for the first five months of 2016 are up about 2% from the comparable period last year, suggesting that auto sales may be in the process of leveling out.
Manufacturing gets a breather
The ISM manufacturing index for May came in at 51.3, up from 50.8 in April and the third straight month of expansion for the manufacturing sector. A weaker dollar, thanks to the Fed stepping back from the pedal this year, and a rebound in oil prices have clearly helped.
That manufacturing is slowly coming out of its beleaguered state was belied in the factory orders data for April. New orders for manufactured goods increased 1.9% in April, on top of a 1.7% rise in March – the first back-to-back months of increase since June-July 2014.
Consumption solid but inflation still below Fed target
The personal income and spending report brought good news early last week. On the personal consumption side, spending in April rose 1% month-over-month, on the back of a drop in the personal savings rate from 5.9% to 5.4%. Real personal consumption expenditures (real PCE) rose 0.6% month-over-month in April after being unchanged in March.
As the next chart illustrates, real PCE is up 3% year-over-year, pointing to the continued resilience of the U.S. consumer and making the best case against a recession in the immediate future.
The PCE price index indicated that inflation was firming but still below the Fed’s 2% target. Core PCE (stripping out food and energy), the Fed’s preferred measure of inflation, rose 1.6% in April, exactly as it was in March.
The personal spending report bolstered the case amongst the hawks in the Federal Reserve. At least for a few days, until the ugly payroll numbers were released on Friday.
Home prices continue their steady rise
The S&P/Case-Shiller home price index reported a 5.2% annual gain in March, down from 5.3% in February. The 10-city composite and the 20-city composites’ year-over-year gains remained unchanged at 4.7% and 5.4%, respectively from the prior month.
The chart below shows that housing continues to make a slow and steady recovery. The National Index is 3% from its peak.
Construction spending declined 1.8% month-over-month in April after rising 1.5% in March, a data point that does not bode too well for Q2 GDP growth. Note that construction spending was still higher by 4.5% year-over-year.
Setback in Services PMI
The non-manufacturing ISM report for May clocked in at 52.9, down from 55.7 in April and well below expectations. This is the seventy-sixth straight month of expansion in the services sector, but the deceleration in May is definitely qualifies as a setback for the largest part of the U.S. economy.
Yellen remains cautiously optimistic
Fed Chair Janet Yellen was clearly concerned about May’s payroll numbers in a speech on Monday, even as she emphasized that one should never attach too much significance to any single monthly report. As she mentioned, other indicators of the labor market (like unemployment claims) have continued to remain positive.
As one would expect, markets were less shy about expressing the impact of a poor payroll report. The probability of a rate hike in June, as determined from Federal Funds futures data, fell to 6% after the report was released, from 21% the previous day.
On balance, it appears that the Fed chair is cautiously optimistic about the economy but was coy about the timing of interest rate hikes. She ended her speech saying:
“I expect the U.S. economy will continue to improve and why I expect that further gradual increases in the federal funds rate will probably be appropriate to best promote the FOMC’s goals of maximum employment and price stability.”
In her speech, Janet Yellen also listed four important uncertainties, including
- Whether domestic demand would remain strong amid global bumpiness and weak investment demand
- Financial stress abroad amid economic challenges, including those faced by China and more immediately, the potential for Brexit
- Weak labor productivity in the U.S.
- How quickly inflation moves back to their 2% target
With inflation stubbornly remaining below target amid seemingly stalled wage gains, and labor market data that just surprised to the downside, one would expect the Fed to back away from raising rates at the June meeting. While they do seem rather eager to raise rates this year, it appears that they are cognizant of asymmetric downside risks that could flip the economic situation around rather quickly.
Bottom line: a mixed bag of data continues to pull the Fed away from ‘policy normalization’.
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