Often, equity investors prefer seeing strong employment growth over more moderate employment gains. But the April nonfarm payroll figures were weaker than expected - and this was considered good news for the equity markets. At first blush, this may not make sense. But consider the fact that equity investors are worried that the Fed will keep on raising the fed funds rate target and not stop soon enough. Equity investors walk the tight rope between strong economic growth that generates corporate profits and sufficiently low interest rates that won't discourage spending. Fed officials may or may not interpret the April employment report the same way as equity investors. The report had an interesting combination of good and bad news depending on which perspective one considers. One can be sure that Fed officials will scrutinize every aspect of the report!
Among large cap blue chip companies, the Dow Jones industrial average, called the stock index of the old economy in the late 1990s, is up 8 percent from year end - posting larger year-to-date increases than the S&P 500 and the Nasdaq composite index, both up 6.2 percent. The Russell 2000, measuring the small cap sector, is up 16.1 percent from year-end levels.
BONDS
It was an interesting week in the bond market, partly a reaction to what is being dubbed the Bartiromo Affair. Maria Bartiromo, CNBC anchor, announced Monday afternoon that Fed Chairman Ben Bernanke told her at a weekend White House correspondents dinner that markets had misunderstood his testimony before the Joint Economic Committee! He told Bartiromo that his comments about a "pause" were not intended to imply that the Fed would stop raising rates. Just like that last week's "dovish" sentiment was reversed and the Fed is now "hawkish" once again.
Nevertheless economists, who are much maligned both for the accuracy and the number of times they revise their forecasts, continue to look good. Economists have always thought the Fed would be headed towards 5 or 5.25 percent on the fed funds rate target. While bond investors get excited or depressed about each comment made or not made by Fed officials from one week to the next, economists have generally remained steadfast in their views.
The key is that Fed officials, including Ben Bernanke, have consistently voiced their view that Fed policy is no longer on automatic pilot but is data-dependent. If inflation stops accelerating and economic activity cools down this summer, as many have been predicting, then the Fed will be able to stop raising rates soon. However, if inflation grows more rapidly and economic activity roars, the Fed will have to raise rates past this summer. The Fed pause scenario could still have rates going to 5.25 or 5.5 percent, but taking a few more months to get there.
Markets at a Glance
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
The Economy
APRIL PAYROLLS INCREASE LESS THAN EXPECTED
Nonfarm payroll employment increased 138,000 in April after downward revised gains of 200,000 in each of the two previous months. While the April gains appeared disappointing to some analysts and market players who have become accustomed to larger monthly increases, they are not necessarily indicative of a weak economy. Historically, monthly payroll gains of roughly 150,000 were considered normal and good in the mature phase of an economic expansion. Given a different demographic structure of the economy, coupled with slower labor force growth and relatively healthy productivity gains, some economists have suggested that 125,000 average monthly gains in payrolls in a mature phase of an expansion should be considered reasonable. We are nearly five years past the 2001 recession and real GDP levels long ago reached new highs in this business cycle. The previous peak in nonfarm payrolls was reached in February 2001; a new peak was reached in February 2005. While employment growth may have been sub par during the economic recovery, it did eventually recover. Given the current environment, the April gain shouldn't be considered all that bad. However, it is not likely that average monthly gains of less than 150,000 will generate the same robust pace of GDP growth that we saw in the first quarter (approaching a 5 percent rate). But steaming growth in a mature expansion is exactly the kind of nightmare Fed officials want to avoid.
Fed officials prefer more moderate growth because excess demand for labor, that can't be satisfied, leads to wage pressures. Average hourly earnings increased 0.5 percent in April, after posting average gains of 0.35 percent over the four previous months. Clearly, this was a jump, but it is not unusual to see outsized gains from time to time - and sometimes these are even revised away. That said, the year-over-year 3.8 percent rise in average hourly earnings is the largest gain since August 2001. However, it is useful to see how real wages are behaving by comparing the year-over-year gain in average hourly earnings to the year-over-year gain in the total CPI. The Fed and market players stubbornly focus on the core CPI, which excludes food and energy. But wage earners cannot exclude food and energy from their budgets. Yes, month-to-month fluctuations in the total CPI can obscure underlying trends, but energy prices have not fluctuated very much - they have simply increased by different magnitudes.
The chart below shows that average hourly earnings have generally increased more rapidly than the CPI between 1996 and 2004. This shifted in 2004, and for the past two years the CPI has outpaced wages. No one really disputes this, but it is obscured in the discussions that focus entirely on the core CPI.
Federal Reserve officials do not want to see a wage-price spiral develop - where wage increases accelerate to keep up with inflation. That's why it is important to nip inflation in the bud. Wage demands are not going to accelerate if the economy is moderating. If nonfarm payrolls increase 150,000 per month or so, it would not signal robust GDP growth and it might keep wage growth under better control. The combination of slower nonfarm payroll growth with higher wages might be viewed less unfavorably by Fed officials than robust employment gains with higher wages.
JOBLESS RATE STABLE
The civilian unemployment rate remained unchanged at 4.7 percent in April. In 10 of the past 12 months, the jobless rate has stood at 5 percent. Believers in NAIRU (nonaccelerating inflation rate of unemployment) estimate NAIRU at 5.2 percent. Fed Chairman Ben Bernanke is more inclined to believe in economic models than his predecessor. Given the Fed's study that structural changes in the labor market will prevent the labor force participation rate from improving very much (See April 5 Short Take, "Labor Force Participation and the Unemployment Rate"), one would expect there to be concern over the current jobless rate. Also, the employment-to-population ratio has been on the rise in the past year. It remains low by historical standards but perhaps not particularly low for this stage of the business cycle if one accounts for structural changes in the labor market.
I don't remember the last time that I used this chart of average weekly hours in an article. The average workweek doesn't change much in the short run, although long run depictions have shown a sharp downward trend. Notice that average weekly hours increased by 6 minutes in April to 33.9, bringing the average workweek to its highest level since September 2002. Employers would tend to increase the number of hours worked in advance of increasing employment if they weren't sure that increased demand would be permanent. But employers might also increase the number of hours worked if they couldn't find new employees to fill spots, or if they did not want to hire new workers at increased wages.
FROM THE WALL STREET JOURNAL
"Shortages have emerged for workers with key technical skills, even as many ordinary workers cannot find jobs offering good pay and decent benefits. The job market continues to display a disturbing dichotomy-a booming market for the top quartile and a mediocre to lousy market for everyone else. It's caviar for the best and cake for the rest." Peter Morici, University of Maryland
NONFARM PRODUCTIVITY REBOUNDS IN Q1
Nonfarm productivity expanded at a 3.2 percent rate in the first quarter after dipping at a 0.3 percent rate in the fourth quarter. The improved productivity figures stemmed from the stronger pace of economic growth in the first quarter with real GDP growing at nearly a 5 percent rate. In the past few years, healthy productivity growth has been accompanied by declines in unit labor costs. This was not the case in the first quarter, as unit labor costs increased at a 2.5 percent rate. Granted, this was less than the fourth quarter's pace, but still firmly positive. Unit labor costs are a better indicator of inflationary pressures than average hourly earnings, and are somewhat less dire than the April hourly earnings figures. Nonetheless, they do point to accelerated labor costs.
Productivity jumps around from quarter to quarter, dependent on GDP growth and employment growth. It is more useful to look at year-over-year trends. In the first quarter, nonfarm productivity was 2.4 percent higher than a year ago, on par with the fourth quarter's pace. Productivity gains have remained in a tight 2.3 to 3.1 percent range since the fourth quarter of 2003. Of course, productivity growth was more robust from 2002 to the third quarter of 2003, but keep in mind that we weren't seeing much improvement in employment in the first few years of recovery after the 2001 recession.
The Bottom Line
Economic indicators were abundant this week, but whenever the employment situation is reported, it takes precedence over all other economic indicators. The employment report can be seen as good or bad depending on how it is interpreted. If one is looking for robust economic growth coupled with strong employment gains, then the April news was less than stellar. However, if one is concerned that overheating in the economy will lead to unbridled inflationary pressures, then the weaker-than-expected nonfarm payroll gain can be considered good news. One needs to take into account that rapidly growing wages usually are a problem for Fed officials who worry that wages pressures lead to price pressures. Of course, if employment growth moderates, eventually wage growth will moderate also. Consumers, of course, would rather that their wages keep up with inflation - and this has not been the case for the past two years.
The FOMC is meeting on Wednesday and everyone believes they will announce a 25-basis-point increase in the fed funds rate target to 5 percent. The post-meeting statement should give us a clue about future movements in the funds rate target. Bernanke is a proponent of transparency and disclosure. Yet, his comments in the past couple of weeks have caused markets to flip flop. I would expect that the Fed will take some extra time in making some useful changes to the post-meeting statement.
Looking Ahead: Week of May 8 to May 12
Wednesday
The U.S. Treasury will release the monthly budget report for April, which typically shows a substantial surplus for the month. Over the past 10 years, the average surplus has amounted to $95 billion in April.
Treasury Budget Consensus Forecast for Apr 06: $120 billion
Range: $60 to $125 billion
The FOMC will meet to determine the course of monetary policy. It is generally expected that the Fed will announce a 25-basis-point rate hike that will bring the fed funds rate target to 5 percent. Since Fed Chairman Ben Bernanke and other Fed officials have been offering different sorts of information in their speeches, it will be most interesting to market players to see if the post-meeting statement offers any new clues to future policy changes.
Fed Funds Rate Target Consensus Forecast for May 10 06: 5.0 percent (+0.25 percent)
Range: none
Thursday
New jobless claims rose 5,000 in the week ended April 29 to 322,000, and the 4-week moving average increased to 314,250. This brings the average level of claims in April above the March average.
Jobless Claims Consensus Forecast for 5/6/06: 315,000
Range: 310,000 to 325,000
Retail sales rose 0.6 percent in March, nearly offsetting February's 0.8 percent drop. Motor vehicle sales decreased 1.5 percent in April and could dampen total sales. In contrast, gasoline prices have been on the rise in April - and this should help bolster nonauto retail sales for the month. Keep in mind that higher gas prices don't lead to stronger real retail sales.
Retail sales Consensus Forecast for Apr 06: 0.7 percent
Range: 0.4 to 1.0 percent
Retail sales ex autos Consensus Forecast for Apr 06: 0.8 percent
Range: 0.3 to 1.2 percent
Business inventories were unchanged in February with declines in manufacturing and retail trade inventories. Thus far, manufacturers' inventories rose 0.7 percent in March. Wholesale trade inventories and retail trade inventories are still unavailable.
Business inventories Consensus Forecast for Mar 06: 0.5 percent
Range: 0.2 to 0.6 percent
Friday
The international trade deficit on goods and services narrowed in February to show a $65.7 billion shortfall after widening in January. Exports fell 1.1 percent in February while imports decreased 2.3 percent. If the March figures are much different from the Commerce Department's expectations, it could impact their advance estimate for first quarter GDP growth.
International trade balance Consensus Forecast for Mar 06: $-67 billion
Range: $-63.5 to $-71 billion
Import prices fell 0.4 percent in March as petroleum import prices decreased 0.7 percent for the month. Crude oil prices were higher in April and this should boost the index.
Import prices Consensus Forecast for Apr 06: 1.2 percent
Range: 0.7 to 1.8 percent
In April, the University of Michigan's consumer sentiment index fell 1.5 points to 87.4. Labor market conditions have generally improved, but consumer attitudes may not be improving because gas prices are surging and interest rates are rising as well - increasing borrowing costs.
Consumer sentiment Consensus Forecast for mid-May 06: 87
Range: 82 to 90
Good news or bad news'
